Annuities Guide: What is an Equity Indexed Annuity?

Aug 9, 2010
Carol Finch

: Equity Indexed Annuities Guide - Image by svilen001

Equity indexed annuities come with both fixed and variable investment benefits. What is a hybrid annuity and how does it work?

Having to choose between fixed or variable annuities may not give an ideal solution to some investors. Some will opt for a hybrid or combination product instead. What is an equity indexed annuity and how does it work?

What is an Equity Indexed Annuity?

Like other annuities, an equity indexed product allows an individual to buy a form of insurance that can be converted into income at a later date. This is usually used to provide money in retirement. This option is often described as a "best of both worlds" solution that brings both fixed and variable payment components to the table. This may give a better return than a fixed annuity without the risks of a variable option.

So, for example, equity indexed annuities will pay a guaranteed minimum when they mature like a fixed product. But, they may also give an income boost as they incorporate a variable element linked to a stock market index. If this performs well then an annuity may pay out more than the fixed minimum. If performance is low, then the guarantee gives some security.

How do Equity Indexed Annuities Work?

Individuals buying hybrid annuities can either make a one-off cash payment or regular contributions to fund a purchase. Some will start this process earlier in their working life as part of a long-term retirement planning process; others may buy an annuity as they reach retirement or when they have actually retired.

Annuity payouts may vary depending on the initial deal. Some may be made as lump sum payments; others may give a scheduled income (i.e. monthly, quarterly or annually). In some cases a product may give an income for life; in others the income may only last for a set number of years.

Immediate and Deferred Equity Index Annuities

Those that buy an equity index annuity early with a view to creating an income later in life will buy what is known as a deferred product. In some cases, however, individuals may have a shorter term need and may then choose to buy immediate annuities. These start to pay out much quicker than deferred options which may not mature for years.

This often happens close to or in retirement. An individual who worries about having a large enough income to fund later life and who has a cash lump sum available may find that this is an investment solution worth considering.

Alternatives to Equity Indexed Annuities

Although these annuities may exceed the returns given by fixed products and remove some of the risk of variable options, they may not suit everyone. Individuals may need independent financial advice to establish if this is the best solution as an equity indexed annuity can be complicated and hard to understand without experience. The fees involved may also make this less attractive to some.

Those looking for guaranteed returns may want to consider fixed annuities. Investors that are not so worried about risk may find a straight variable annuity the best deal. The following articles may also make useful reading:

Source: CNNMoney.com (" Annuities "). Accessed online 9th August 2010.