The difference between indexed annuities and other annuities
An annuity that is tax-deferred in nature and tied to an equity index such as the S&P 500 is known as in indexed annuity. They were once referred to as equity-indexed annuities, but equity was dropped from the terminology so as not to imply being tied to the stock market. This type of annuity typically carries a guaranteed rate of interest between 1% and 3% if it is held until the end of the surrender period. Additionally, one is protected against losing the principal with indexed annuities.
This type of annuity is normally a contract between the annuitant and either an annuity company or an insurance company. The returns realized with indexed annuities is typically greater than that of bonds, CD’s, and money market accounts. However, they are not as great as stock market returns. One thing that you want to be aware of is that the guarantees of an indexed annuity are only as good as the issuer. In other words, should the annuity or insurance company fail, the guarantees are worthless.
Functions of indexed annuities
Indexed annuities are basically an investment option and provide the investor with guaranteed gains and minimal levels of risk. There are 3 basic characteristics of this type of annuity as follows:
Periodic payments or lump sum – one of the better functions of indexed annuities is the payment option. You can choose to have periodic payments (usually monthly) so as to replace your income or supplement your retirement income. However, most individuals contribute into this type of annuity throughout their working lives. Usually, there is a minimum investment made up front, and then further contributions can be made.
The other payment option is the lump sum option wherein the payout is made with only one payment. You purchase an indexed annuity with a lump sum. Most individuals who have saved money over their working years will invest in the annuity once they reach retirement age. Unfortunately, this can involve giving the annuity or insurance company hundreds or thousands of dollars all at one time.
Guaranteed minimums – the benefit of indexed annuities is that they do not always involve full exposure to the stock market, therefore minimizing your risk of loss of principal. The benefit here is that no matter what direction the stock market goes in, there is a guaranteed minimum that you will earn. Even though you are still trying to profit based on upwards movement in the different markets, there is still a safety level that you are provided with when investing in indexed annuities.
Investment caps – despite the ability to profit based upon financial index increases, there are earnings caps on what you have the potential to earn. For instance, an indexed annuity may have an earnings cap of 7%. Even if the financial index earns twice that, you will only realize 7% earnings. So what this means is that your earnings potential is somewhat limited with these types of annuities.