EIAs are a type of fixed annuity with a minimum interest rate
guarantee that credits additional interest based on the performance
of a stock market index it is tied to (such as the Standard and
Poor’s (S&P) 500 Index), using one of more than 30 different
interest-crediting formulas. Lured by the prospect of high returns
and low risk, investors poured more than $13 billion into EIAs
during the first half of 2005, according to an Oct. 15, 2005, Wall
Street Journal article.
EIAs reward salespeople with high commissions, up to 8 percent. But
are they a good deal for investors? Understanding these components
can help you decide.
Participation rate: This is the percent of the underlying
index that is credited to your account. It typically ranges from 50
percent to 90 percent. For example, if the participation rate is 70
percent and the index to which it is tied advances 9 percent, the
interest credited to your account would be 7.2 percent. A 70 percent
participation rate against the S&P 500 simple price index only
credits 4.76 percent. Most EIAs use a simple price index that
doesn’t credit dividends. In the past 40 years, the S&P 500 index
has averaged 10.4 percent including dividends, but only 6.8 percent
without dividends.
Return cap: This is the maximum amount of interest you can
earn, regardless of the underlying index returns. Some EIAs have no
caps, but many impose a return cap.
Margin, spread, and administrative fees: Sometimes these
are deducted from the return instead of a participation rate. If the
underlying index returns 8 percent, but the spread is 3 percent,
only 5 percent is credited to the EIA.
Guaranteed or minimum interest: The minimum interest rate
guaranteed on an EIA is typically between 1.5 percent and 3 percent.
However, that minimum usually is only guaranteed on 90 percent of
premiums paid, and there often is no guarantee on withdrawn amounts.
Surrender charges: EIAs come with hefty surrender charges
and long surrender periods (the current average is 10 years, but
some approach 20 years). Typically, the more attractive the
interest-crediting terms or other bonus features, the stiffer the
surrender penalties.
Confused yet? As if EIAs weren’t complicated enough, many
contracts allow insurance companies to change participation rates,
caps, and guaranteed interest on an annual basis.
EIAs could be a poster child for the adage, “Never invest in
something you don’t understand.” These complex products with many
moving parts are so complicated that even some people selling them
can’t adequately explain them. Make sure you do your homework before
signing on the dotted line.
— Former Army Capt. Phil Dyer, CFP, is
deputy director for financial education, Benefits Information. For
financial advice, members can contact Garrett Planning Network at
(866) MOAA-GPN (662-2476) or
www.garrettplanning.com,
or visit
www.moaa.org/financialcenter for other resources.
