Annuity Cash Outs

I found this on the DailyBreeze:

Whether equity-indexed annuities, EIAs for short, are a godsend or quicksand does, in fact, depend on whom one speaks to. The attraction is obvious: EIAs, offered through insurance companies, are structured to incorporate market-driven movement with the guaranteed return of an annuity. That might give EIAs an edge over standard fixed annuities and a bit more stability than variable-rate annuities, but they’re not quite that simple.

Why? EIAs’ rates are determined based on the performance of the stock market index, such as the S&P 500 that’s used by many EIA issuers, to which the annuity is tied. Some issuers measure the gain each month, while others use a year-to-year method.

That means, for example, that an EIA might guarantee 3 percent annual return and add on a percentage, typically around 85 percent, of the index’s annual increase. Most cap the potential annual gain at somewhere between 7 percent and 11 percent but will only guarantee up to 90 percent of principal — in addition to the annual guaranteed return, usually 3 percent. If the index jumps substantially over the year — 20 percent or more — the returns would beat the heck out of a money market. But what’s confusing is that companies use a so-called “participation rate” to determine how much of the gain the investor receives. If it’s 85 percent, and the index rises 5 percent in a given year, the investor’s account is credited with a 4.25 percent return.

That sounds pretty good on the surface. But these investments can be complex. For example, the EIA company calculates gains in one of several ways, ranging from the market price on the day the EIA matures to an average of the gains for each year of the contract period. EIAs also can be costly from the standpoint of large surrender fees and potential penalties for early bailout. The penalties often can last 10 years. This could be financially painful if the investor should need some of or all of their money in less than a decade.

The tax picture is also a consideration. EIA withdrawals are taxed as income, while gains from an S&P index fund would be subject to the usually lower capital gains rates. On the other end of the spectrum, while EIAs protect against some of the market’s downside risk, dividends are excluded, which means investors could earn less than they might have had they invested directly in the market.

In addition, it’s important to remember that guaranteed returns may be structured differently from one EIA to another, and most are contingent upon staying in the annuity for the full term. One company might guarantee 3 percent on total monies in the policy, while another may guarantee the 3 percent on only 80 percent to 90 percent of the principal the investor put into the product. The difference between the two figures could be substantial.

The final potential downside is that EIAs, although based on stock market instruments, are not regulated by either the Securities and Exchange Commission or the National Association of Securities Dealers. Because they’re insurance contracts, they fall under state regulation. In addition, EIAs can be sold by individuals who don’t have a securities license.