Monday, May 02, 2005

EIA Index Annuity Cont'd

We are still dissecting the article from 4/25. Full credits to the source of this article can be seen on the actual 4/25 post. This Equity Index Annuity article is in black and my comments are in red.

How is an EIA's index-linked interest rate computed?
The index-linked gain depends on the particular combination of indexing features that an EIA uses. The most common indexing features are listed below. To fully understand an EIA, make sure you not only understand each feature, but also how the features work together since these features can dramatically impact the return on your investment. [This is where the insurance company can limit your earnings. You need to be aware of these methods. What you need to understand is these insurance companies must put these safety measures in place. However, many companies (discussed further in 'Equity Index Annuity Exposed) are notorious for minimizing the amount a client can make in subsequent years after year 1. This is especially true with high bonus annuities.]

1) Participation Rates. A participation rate determines how much of the gain in the index will be credited to the annuity. For example, the insurance company may set the participation rate at 80%, which means the annuity would only be credited with 80% of the gain experienced by the index. [Not only do you need to understand this but you need to kow if this is a method your company subjects you to, you need to see what the minimum participation rate they can assess on your account. What I mean is that, each year, the company has the right to declare what your participation rate is for the year. Sometimes they can severely mitigate your potential gains by lowering this too much. Be careful]

2) Spread/Margin/Asset Fee. Some EIAs use a spread, margin or asset fee in addition to, or instead of, a participation rate. This percentage will be subtracted from any gain in the index linked to the annuity. For example, if the index gained 10% and the spread/margin/asset fee is 3.5%, then the gain in the annuity would be only 6.5%. [Again, one to watch out for...not just what it is the first year, but what the company can bring this down to]

3) Interest Rate Caps. Some EIAs may put a cap or upper limit on your return. This cap rate in generally stated as a percentage. This is the maximum rate of interest the annuity will earn. For example, if the index linked to the annuity gained 10% and the cap rate was 8%, then the gain in the annuity would be 8%. [This is probably the most common form of how the insurance companies control your potential gains. As we presently speak, this number is between 8% to 12% depending on how much time you are willing to commit to in your annuity. Once again, it is very wise to know how low this number can go. Presently, many companies are stating the minimum you can ever have your cap down to is 5% but I actually have seen a minimum allowed rate of 0%]

Caution! Some EIAs allow the insurance company to change participation rates, cap rates, or spread/asset/margin fees either annually or at the start of the next contract term. If an insurance company subsequently lowers the participation rate or cap rate or increases the spread/asset/margin fees, this could adversely affect your return. Read your contract carefully to see if it allows the insurance company to change these features. [Most contracts give the insurance company the right to declare this every year. This is not unusual. It is wise to see the renewal rate histroy of the company you are choosing to see if they have been generous or not with their clients.]

[One more comment---I can't stress it enough. These safety nets have to be built in by the insurance company for their protection and for YOURS. However, it is up to them how they take advantage or abuse these rights. Some companies are extremely generous and these are the companies you'll want to deal with. Do some homework on renewal rates and you may find some pleasant and some unpleasant surprises!]

Ignorance is Not Bliss!!!

For more annuity information:

Annuity 1
Annuity 2
Annuity 3

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