(b)lines Ask the Experts – What Is an Equity Indexed Annuity?

“I recently found out that the 403(b) plan our firm sponsors contains something called an ‘equity indexed annuity.’ Can you explain to me exactly what that is, as I have never heard of the term before? Thanks!”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

Certainly! An equity indexed annuity, also known as an indexed annuity contract, is an alternative to the two primary types of annuities that we discussed in a prior Ask the Experts column; namely, fixed and variable annuities.

Instead of offering the fixed investment return of a fixed annuity or the variable investment return of a variable annuity, the equity indexed annuity offers a little bit of both. Like a fixed annuity, there is a minimum crediting rate guaranteed by the insurer, and, like a variable annuity there is a component of the product’s investment return that is linked to a specific equity index. Thus, the product generally offers a higher return than fixed annuities, but a lower return than variable annuities, in exchange for downside protection in the event the related index declines in value, via the minimum crediting rate. Now, of course, in exchange for this downside protection, the participant pays additional fees over and above the cost of a fixed or variable annuity. In addition, there are fees to cancel the contract.

And finally, this type of investment is often difficult for participants to understand, as the method of calculating the indexed return is complicated and varies by insurer—everyone is different. That is why such investments are less common in 403(b) contracts than traditional fixed and variable annuities.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.