Be Alert, Know Your Equity Annuity

First things first, an equity annuity or Equity-Indexed annuity (EIA) goes under the category of a fixed annuity. If you happen to get an EIA, during the accumulation period, your insurance company will credit your principal investment money with a return that is based on the adjustments of an equity index. The accumulation period is the time during which you are making contributions to your annuity contract, which can be by lump sum or staggered payments.

So what is an equity index? It is a type of market index which tracks the performance of a particular 'basket' of stocks which represent a specific market or sector of the US stock market or at times, the economy.

There are five chief indexing methods which govern an equity annuity. Of course, all interests credit are index-linked based but the difference lies to which they were based. The European Method (point-to-point) credits the interests from the start until the end of the annuity contract. The Look-back Method (high-water-mark) also credits from the start until the end of the contract. However, it includes the highest index value at some points of the contract's term. Lastly, the Annual Reset method (cliquet or ratchet) which credits the profits based on any increase in the index value in a year.

Normally, the financial company which is offering you the equity annuity will guarantee a minimum earning and these usually varies. Once the accumulation phase is done, the financial institution will now make periodic or lump sum payments, depending on what is agreed on the terms of your contract.

Since EIA's are somehow much more complex products compared to other fixed annuities, you have to fully understand the factors which can affect the credits you will be receiving:

• Margin/Spread/Administrative Fee- some annuities determine their index-linked interest rates by deducting a percentage from any increase in the index
• Participation Rates- determines how much of the indices' increase will be used in computing the index linked interest rates
• Interest Rate Caps- the maximum rate of interest that an EIA can earn, as agreed on the contract

Of course, it is not all rose colored for an equity annuity. There is a possibility that you will lose some money, especially if you are to cancel your annuity earlier than what has been agreed on your contract. It takes several years for an EIA's minimum guarantee to break-even. So even though you have a guarantee, if the guarantee is less than the full amount of the purchase payments, then might just have to say goodbye to some of your money. Sad but true. So you just have to careful and wiser on type of investment you will be venturing into.