Stock Market Returns without the Risk…Are you kiddin me?

Am I kidding you?  ABSOLUTELY!

If you have retired recently, or are going to be retiring soon, you have probably been hit up to purchase an Equity Indexed Annuity (EIA).  No?  Oh, that’s probably because the financial service industry has done a bang up job of marketing.  You may not have even been told it’s an annuity.  You’ve probably heard how you can get “Stock Market Returns without Risking your principal.”  WOW!  If that were the case, who wouldn’t do it.  The sad truth is, retirees are doing it by the truckloads.

Total 2011 indexed annuity sales set a record at $32.3 billion dollars, capping off a fourth consecutive record year.  So why are retirees flocking to these investments while the state insurance departments and the Financial Industry Regulatory Authority (FINRA) has issued warnings about these products (click here to see the FINRA warning)?  The answer is simple.  Financial salespeople motivated by large commissions and incentives!

Now, before I get a bunch of angry emails from EIA reps…Can an Equity Indexed Annuity ever be a good choice?  Possibly, but you probably won’t find it from the rep who is inviting you to a free dinner seminar or giving you a “complimentary consultation.”  So, how do you protect yourself?  Knowledge!  You need to know enough about the product to recognize it when you see it.  So keep reading and you will…

An EIA is simply an annuity that links its return, interest rate, payout, annual credit (whatever they may call it) to the return of an associated index…typically the S&P 500.  In other words, the return you get on your money will be linked to what the S&P 500 index return is for the year.  Sounds simple enough…but the truth is that it is far from simple.  These products are extremely complex and the crediting methods are even more.  The return you get may be tied to the S&P 500, but it is far from equal to that return.  Why?  Because the insurance company has to guarantee your principal.  Let’s just say they compensate themselves by taking part of your return, charging you a fee or both.

Most plans take part of your return by setting a cap on the return they pass on to you or setting what is called a participation rate.  For example, they may set a cap of 8 % meaning you will get whatever the S&P 500 returns for the year up to a maximum of 8%.  So, if the S&P returns 6% for the year then you get 6 %.  If it returns 15% for the year, you only get 8%.  A participation rate is similar but is a percentage of the total return.  For example, 90% participation rate would mean you get 90% of whatever the S&P 500 returns for the year.

“So what is the problem?” you may be asking.  Join me for Part 2 of this series where I will discuss some of the problems and what you can do to protect yourself.

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