Indexes such as the S&P 500 reflect the performance of the stock market. In indexed annuities, these indexes are used to determine how much interest can be recovered. The better the markets perform, the more interest the annuity holder can collect. However, if the market performs poorly, interest rates fall to lower levels. This is similar to how an indexed universal life insurance policy is tied to market performance.
How Does an Indexed Annuity Work?
As a part of an equity indexed annuity, accountholders pay premiums into the account. Each year, interest is credited to the account at a rate which depends on the performance of a market index. Growth of the index is measured in year over year gain or by averaging the monthly gain over the course of 12 months.
Unfortunately, equity indexed annuities may not always match an indexes’ full return. The exact returns will depend on an annuity’s participation rate and any caps associated with the contract.
Terms of an annuity will include a “participation rate” which limits the potential gain of an index to a certain percentage. For a 100% participation rate, any growth of the index would be reflected in the account. Most participation rates are between 80% and 90% but these rates could be as low as 25%.
Similarly, a yield or rate cap will limit the amount of interest which can be credited to an account. Rates may range from 4% to 15% and may even change over the term of the annuity. For example, if an account has a 7% rate cap, an account would only be credited with 7% of a yield even if the full return is much higher.
Although there are caps on annuity yields, most contracts also include a minimum rate between 0% and 3%. This ensures that, even if the market index declines, accounts won’t be penalized.
With many rates to keep track of, it can be hard to understand exactly how much an index annuity will grow.
For an 80% participation rate, 15% growth of a stock index will translate to a 12% credited yield. However, if the example account has a rate cap of 10%, the credited yield will be reduced to 10% instead of 12%.
On the flip side, if the account’s stock index trends downwards in a year, the account would have a 0% credited yield. However, if the account had a minimum rate of 2%, the credited yield would be 2% instead of 0%.
Understanding these terms and how an index annuity works can be important to make sure consumers aren’t taken advantage of.
How Does an Indexed Annuity Differ from a Fixed Annuity?
A fixed annuity is similar to an indexed annuity in that they are both insurance contracts which pay a return based on an interest rate. However, a fixed annuity pays out a specific, guaranteed interest rate. This differs from index annuities which have a variable interest rate.
Can You Lose Money In an Indexed Annuity?
Losing money is possible with indexed annuities, according to the Financial Industry Regulatory Authority. In most cases, companies only guarantee that consumers will receive 87.5% of the premiums they paid in addition to interest between 1% and 3%.
With interest, consumers may not lose any money, but they are likely to lose money if they don’t receive interest. Interest may be denied to consumers if the index at issue declines or if they surrender their annuity before it reaches maturity.
Surrender charges may also be significant – running as high as 20% of the amount withdrawn – and can result in tax penalties which cost investors more money than expected.
Do Companies Exaggerate Projected Returns from an Equity Indexed Annuity?
Unfortunately, consumers may be misled by insurance companies’ representations about the performance and returns of equity indexed annuities. If consumers make decisions based on false information, they may be unprepared for the risks associated with these investments.
According to CNN, equity indexed annuities are complex investments which vary widely. As a result, it may be hard for investors to understand the exact details behind the contracts, what they can expect, and whether or not their insurance companies are misleading them.
Attorneys are looking into several equity indexed annuity companies to see if they may have used false projections as sales tools when advertising the annuities. Companies included in this investigation include:
Nationwide
Athene
Minnesota Life
North American
American General/AIG
Free Equity Indexed Annuities (EIA) Deceptive Marketing Case Evaluation
If you purchased an EIA, you may have been misled into purchasing your EIA due to deceptive marketing practices. If so, you may be eligible to join this Equity Indexed Annuities Deceptive Marketing Class Action Lawsuit investigation.
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