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Answer:
Dear
BuyandHolder,
Equity
indexed annuities are not regarded as a totally safe
investment. But then, nothing really is, although
savings bonds, U.S. treasuries, FDIC-insured savings
accounts and CDs as well as money market funds are
about as safe as you can get. But none have the potential
for huge returns.
First,
let's first look at annuities in general. Then we'll
discuss the pros and cons of equity indexed annuities.
What
is an annuity?
An
annuity is a contract between you and an insurance
company in which the company promises to make periodic
payments to you, starting either immediately or at
some future time. If the payments are in the future,
you have a deferred annuity. If the payments
start immediately, you have an immediate annuity.
You purchase the annuity either with a single payment
or a series of payments called premiums.
With
a fixed annuity, the insurance company guarantees
both the rate of return and the payout. With a variable
annuity, the rate of return is not stable, but
varies with the stock, bond and money market funds
that you choose as investment options. There is no
guarantee that you will earn any return on your investment
and there is a risk that you will lose money.
What
are equity indexed annuities?
EIAs,
as they are known, have characteristics of both fixed
and variable annuities. Their return varies more than
a fixed annuity, but not as much as a variable annuity.
So
they have more risk (but also more potential return)
than a fixed annuity but less risk (and less potential
return) than a variable annuity.
EIAs
come with a minimum guaranteed interest rate combined
with an interest rate linked to a market index, such
as the S&P 500. Because of the guaranteed interest
rate, EIAs have less market risk than variable annuities.
EIAs also have the potential to earn higher returns
better than traditional fixed annuities when the stock
market is rising
If
the market goes down
You'll
lose money. However, on the plus side, as mentioned
above, almost all EIAs guarantee a minimum return.
The minimum return rate varies, but is typically 90%
of the premiums you paid plus (at least) 3% interest.
If
the market goes up
You
will definitely make money but the actual amount you
make may be limited. That's because most annuities
put a cap on the interest rate you can earn, telling
you so up front.
BUYandHOLD
does not offer Annuity products. The following illustration
is being used to show how the performance of the underlying
investment accounts could affect the policy cash value
and death benefit. The illustration is hypothetical
and is not intended to project or predict investment
results.
Let's
say the annuity has a cap of 7% and the index itself
goes up 7.2%, then only 7% is credited to the annuity.
Some
companies are less obvious about capping your profit
and resort to the small print where they mention something
called a participation rate. Let's say the
annuity's participation rate is 80%. Then you receive
only 80% of the gain made by the index -- if the index
increases 9%, the return you'll receive would be 7.2%
(9% x 80% = 7.2%.)
Caution:
In some cases, the insurance company can actually
lower the participation rate and the interest cap
annually after you've invested your hard earned
money!
Cashing
in early
What
if you need the money? You could be in trouble. In
fact, you can actually lose money if you need to take
out funds early. You'll probably be hit with a surrender
charge -- a percentage of the amount withdrawn or
a reduction in the interest rate credited to your
account.
There's
also a 10% tax penalty on withdrawals from tax-deferred
annuities before you turn 59 1/2. That's in addition
to any gain that's being taxed as ordinary income!
Regulation
issues
Because
these annuities are insurance products, they rarely
are registered with the SEC -- which means the federal
government does not regulate them. And, because they
are sold by salespeople who earn high commissions,
you won't be surprised to learn that high-pressure
tactics abound.
Bottom
line...
If
you decide to go ahead and purchase an EIA, be sure
you use a broker registered with the NASD. Check:
www.nasd.com.
(Click on "Investor Protection.") Or call the association's
hotline at: 800-289-9999. And, keep in mind that the
average annual fee for an EIA is 2.05%. Don't go with
someone who charges more.
Good
luck!
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