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Answer:
Dear
Dan,
Glad
you asked, as these are fairly complex. They come
with almost an equal number of pros and cons. And,
no they're not stocks, but they are linked to the
stock market.
Traditional
Annuities
An
annuity is basically a contract backed by an
insurance company that guarantees a stream of payments
will be made to an individual, often a retiree, at
predetermined intervals -- usually monthly or annually.
The payments may continue on for a fixed time period
or for a contingent time period -- typically until
the recipient dies.
The
basic benefit -- your money grows and compounds without
being taxed until withdrawn.
These
financial instruments are not offered at BUYandHOLD.
Equity
Index Annuities
When
you purchase an EIA, you are, of course signing a
contract with an insurance company. The company agrees
to pay interest on your account until you begin taking
money out in the form of regular, periodic payments.
These payments are based on three things: one, the
value of the account; two, the interest rate; and
three, the payout period.
EIAs
come with two interest rates. One is a minimum
fixed interest rate below which the rate cannot drop.
The
second is a variable rate that's based on the performance
of one of the stock indexes, the most popular being
the Standard & Poor's 500 Stock Index.
The
advantage of EIAs is that you have an opportunity
to earn higher returns that with traditional annuities
because some of the gains in your account are tied
to the named market index.
The
insurance company determines how much of the stock
index's gain goes into individual annuity accounts.
That amount might be 70% or 80% of the stock index's
gain. So, if the index goes up 10%, the account would
earn 7% or 8%, respectively.
Caution:
Insurance companies often put a lid on the variable
rate. Let's say if the S&P 500 takes off and goes
up 25% but your contract has an 8% cap, you'll be
stuck with only an 8% gain.
This
cap often changes on an annual basis.
Important
Considerations
1)
Early withdrawals: If you take money out in the
early years of your contract, you almost always must
pay substantial penalties. These penalties are called
surrender fees. Many insurance companies impose
surrender fees for 5, 7 or 10 years -- a real negative
for older people.
2)
Age 59 1/2. If you make withdrawals before you
turn 59 1/2, you will be hit with two penalties: a
10% tax penalty and a tax bill on the gains.
3)
Dividends. Most, but not all EIAs, do not include
stock market dividends.
4)
Commissions. Those who sell this type of annuity
are handsomely rewarded. Commissions average about
8% but can be as high as 10% to 15%.
The
Regulation Question
Currently,
EIAs are regulated by the state insurance commissioners
because they are considered an insurance product.
However, the regulation topic has been in the news
recently because the Securities & Exchange Commission
is discussing the possibility that they should be
regulated as securities, and not as part of the insurance
world.
Other
regulators, including the NASD, have stated publicly
that EIAs have misleading advertising that causes
the general public to think they're buying an investment
rather than an insurance product. For this reason,
the NASD maintains EIAs should be classified as investments
and be under greater scrutiny.
The
issue is ongoing and yet to be resolved.
For
Further Information
I
recommend that you study the material on the Web site
of Advantage Compendium, a St. Louis-based
company (www.indexannuity.org).
You'll see that over 40 different companies offer
various types of EIAs -- in fact there are 120+ different
EIA products. This nonprofit group supplies comprehensive
information on rates, commissions and various features
of Equity Indexed Annuities.
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