Equity Indexed Annuities
Another handy way to save for retirement has been gaining media attention.
Maybe you’ve recently maxed-out your 401(k) and your IRA, and you’re still looking for ways to save for retirement and defer taxes. If so, an Equity Indexed Annuity (EIA) may help you meet your financial goals.
Equity indexed annuities take advantage of the security of annuities and potential market gains. Like a regular fixed annuity, you put money into an annuity in return for interest and a steady stream of income after you’ve retired. The value of an equity indexed annuity, both the principal and potential earnings, is entirely dependent on the insurance company’s financial ability to meet its obligations.
With an equity-indexed annuity, you have the potential to earn more future savings depending on the performance of the index to which it’s tied. EIAs are not directly invested in an index or the equities comprising an index. The index is merely the instrument used to measure the gain or loss in the market, and that measurement is used to calculate the interest rate.
One possible downside is that the insurance company with whom you contracted for the annuity can set limits on the amount of market gain you actually receive. While you still have an opportunity for adequate growth, it may not always be at the same level as the index.
Insurance companies can limit your potential gains in several ways. For example, they can put a cap on your growth. If they assign a 10% cap, and the market increases 20%, you get only 10% of the gain. They can also give you only a percentage share of the index performance. For example, if they set the rate at 70% of index performance, and a particular index rose 10%, you would earn 7%. Finally, they can implement margins or spreads. If your margin was set at 4% and the market rose 10%, your annuity would rise only 6%.
How and when interest is credited to your EIA is an essential component as well. Some EIAs calculate interest by comparing your account value at the beginning of the year to its value at year-end. Assuming a gain, the difference is added to your account using the guidelines above. Others take the value of your EIA then add the value gained after the entire term of the EIA, which could be many years.
One of the biggest advantages of EIAs lies in taxes. Future income and earnings in an annuity generally offer tax-deferred growth. This is especially helpful if you expect to be in a lower tax-bracket during retirement.
Keep in mind that EIAs are primarily a retirement savings vehicle and usually have a penalty for early withdrawal. There is an additional 10% tax penalty if you withdraw before age 59½. However, many annuities have a provision that allows you to withdraw 10% of your funds without paying a penalty. Withdrawals will reduce the amount paid to beneficiaries at the time of death. Some EIAs may also charge additional fees that are subtracted from any gain in the index.
Many EIAs have surrender charges, which can be a percentage of the amount withdrawn or a reduction in the interest rate. Some EIAs allow the insurance company to change participation rates, cap rates or other fees annually, or at the start of the next contract term. All of an EIA’s features should be clearly spelled out in the prospectus, sales literature and the contract. Read this material carefully before investing.
As with most investments, there is always risk, and you should consult carefully with a financial professional before you choose to invest. As an alternative to traditional retirement savings, EIAs may be an option to help you plan for retirement. Article by Securities America