Potential growth opportunities co-mingled with true safety within the same financial vehicle is rare to find. Investors are either compelled to risk safety for better growth of the funds or succumb to lower growth prospects considering questions of safety. However, with innovations like Equity Indexed Annuity hitting the insurance sector, you can now expect higher returns along with proper security of your investments.
What is an Equity Indexed Annuity?
Equity indexed annuity is an excellent option if safety is what you are seeking in a volatile market. It offers you return based on the increase of a stock or equity index, such as the S&P 500. If stocks rise, you get the benefit from it. However, if stocks fall, you do not lose any money.
This mode of investment is a safe alternative for retired people and to those approaching retirement because equity indexed annuity guarantees a minimum return of 3 percent. In fact, indexed annuities can be a powerful vehicle if you intend to hold your investments for some time down the line.
Limiting the Maximum Return
While investing in equity indexed annuity it is important to understand that the company issuing the annuity will limit the maximum returns that you get from a rising market in return for the protection against a downturn market. This limit depends upon the kind of indexing method that the company uses.
The Participation Rate
The most common return limiting method is the “participation rate.” In this method, the company might set the participation rate according to their discretion. While some companies set their rate as generous as 90 percent, for many companies it might be as low as only 50 percent.
For example, if the insurance company sets the participation at 80 percent, the annuity would be given with 80 percnet of the growth that the index experienced.
Annual Reset
Added to the participation options, there are also several annuities that employ “annual reset” method to credit interest according to the index. With this method you can lock in profits in an upward market permanently.
In a volatile market with declining index, the annuity resets by locking you in at the presently lower index. Some index annuity renewals are reset at quite lucrative levels. In fact, the lower the reset is, the greater are the prospects of future growth.
Here is an example that would show how the index annuity using the annual reset method would have worked in a bear market:
The 1970s witnessed a prolonged downturn market. In 1973-74, the stock prices dropped over 40 percent. The S&P 500 closed at an all-time high by the end of 1972 and these levels did not retrace until 1980. While the traditional buy-and-hold technique would have taken about seven long years to break, a 90 percent participation index annuity using reset method from 1972 to 1979 would have brought returns of about 70 percent for those seven years.
Consult an Investment Expert
Equity indexed annuity is indeed a great source of comfort during a market slump, but its complex nature is an important aspect to be reckoned with. Therefore, it is advised that before you invest even a dime in the equity indexed annuity, consult with an investment advisor to find out if the option is suited to your financial situation.
Jack Reed is a financial writer with Oak View Law Group, a debt consolidation law firm. He has been writing for more than ten years and helping people to get wise with their money. His interests include attending financial seminars, writing columns and visiting personal finance blogs.
