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Jordan Goodman is the author of Everyone's Money Book, available at 888-201-6300. This is the third edition of the book. You can also visit his Web site at www.moneyanswers.com. He talks with us on Thursday mornings.

August 22, 2002

"The Charm of Equity Indexed Annuities"

Host: Insurance companies selling investment annuities linked to the stock market? Yep...Personal finance expert Jordan Goodman tells us more about it.

How would you like to earn the gains of the stock market and never suffer its losses, all in a tax-sheltered account? Well, step right up and buy an equity indexed annuity (EIA). This is probably the hottest product in the insurance world right now because people are so skittish about falling stock prices.

Here is how an equity indexed annuity works:

The insurance company that sponsors the annuity invests in a mix of Standard & Poor’s 500 index options and zero coupon bonds. If the S&P 500 rises, you get some, or all, of the gains, depending on which contract you pick. If the stock market falls, you at least are guaranteed to get your principal back because the zero coupon bonds mature at face value.

    When you buy an EIA, you have various complex choices to make:
  • What is your "participation rate?" In other words, what portion of the S&P 500’s gain do you receive? You can choose from 30 percent to as much as 125 percent.
  • How is the S&P 500’s gain calculated? Some insurance companies use the "point-to-point" method which gives you a flat percentage of return from the starting to the ending point. If the S&P goes from 1200 to 1500 over 10 years, you get a percentage of the 300-point gain. Other companies use the "annual ratchet" method, in which your index value is calculated each year. For example, say the S&P started at 1200 and fell to 1000 after the first year -- you’d lose nothing, but your new starting point would be 1000. If the index rises to 1500, you would get a piece of the 500-point gain.
  • What is the performance cap? Some EIAs will cap the amount of the S&P gain that you get at 15 percent, or less, so if the S&P rises 20 percent, you get 20 percent. (Remember those days?)

What's the downside to EIAs? Fees, for one. Ask your agent what the annual management fees are -- if it is over 2 percent, it is too high. These fees are also known as the "yield spread." EIAs also don't offer the current yield of a fixed rate annuity. Also, in a bull market, you don’t want your gains capped, as they are in an EIA. But since we're in a bear market, these are hot sellers because people want to be assured that at least they won’t lose their principal.

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