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An Equity Indexed Annuity provides for upside potential while maintaining a guaranteed minimum return.  Regardless of whether you choose to invest by way of a Single Premium Deferred Annuity (one time lump deposit) or through a series of payments (Flexible Premium Deferred Annuity) the insurance company will credit you with a return that is based on changes of an equity stock market index (S&P 500, Russell 2000.)

Most Equity Indexed Annuities are guaranteed to increase in value by a minimum annual interest rate. This is sometimes referred to as a floor and assures that the interest earned on the investment can never be below zero.  Some Equity-Indexed Annuities may put a ceiling or cap on interest earned as well. The cap is stated as the maximum rate an annuity can earn. Not all annuities are limited by a cap and not all annuities use the actual value of a market index increase, instead the value of the index is seen as an averaging value in many instances.

Issuing Insurance Companies calculate how closely an annuity will mimic a market index increase. This number is a stated as a percentage and is called a participation rate. For example if the issuers offer a 70% participation rate and the equity index rate increases 8%, typically the annuity’s value would increase by 5.6% (70% x 8%=5.6%).  Participation rates are usually guaranteed for a specific time frame and are somewhat based on what it cost the insurance company to hedge through options on the underlying market index. When comparison shopping for an Equity-Index Annuity it is important to understand that this rate can change for new money. A good Annuity Specialist should be able to compare and contrast different participation rates between top rated companies for you.

Another feature to be aware of is the administration fee also called a margin or a spread.  Insurance Companies sometimes charge an additional percentage off the top of any index increase.  For example if the index increase is 8%  an Insurer  charges  2.00% administration fee off the top, it would look like:  8% – 2.00% = 6.00%   then  70% x6.00% = 4.2% to mirror the previous example.

There are also choices and decisions to be made on the way interest is calculated on your index annuity. There are 3 basic methods; Annual Reset, High-Water Mark and Point-to-Point. An Annual Reset or Ratchet offers a set rate annually and the index value is reset at the end of each year.  This method may use a cap or an averaging value on your interest and the participation rate may be lower and could change from year to year.

The second method is a High Water Mark method. In this method the interest is credited to your Annuity based upon the index value at the beginning of the contract term and the highest value of the index on particular dates –usually the anniversary of the annuity purchase.  In the High water Mark method the interest is credited to your Equity Indexed Annuity at the end of the term. This method may also have a lower participation rate and may also use a cap.

The third method is called Point-to-Point.  This approach calculates interest to be credited based on any increase in the index value throughout the term of the contract.  Typically interest is not credited until the end of the term in Point-to-Point.

Though there are many no load Annuities, most do incur an early surrender penalty not unlike a certificate of deposit at a bank. Typically, the surrender charge percentage drops each anniversary date and the best Equity Indexed Annuities allow for interest income to be received without penalty from day one.  Most good EIA’s allow a 10% withdraw each year without penalty as well. This assumes that you have attained age 59 ½. There is a 10 percent penalty exacted by the US government should someone who is younger than 59 1/2 make a premature withdraw.

Administration fees, Margins, Spreads, Resets, Ratchets, Surrender Penalties and underlying Indexes vary from company to company and from product to product.  These provisions can have a dramatic impact on the actual interest credited to your contract, even though the underlying index is the same.  A good Annuity Broker should be able to compare and contrast various Annuity products for you.  Assuming that a suitability study indicates that an Equity Index Annuity is indeed suitable for you, a specialist will have many different products and companies from which to choose.