Differences Between a Fixed and Equity Annuity

When considering the difference between a fixed and equity annuity, investors should remember that equity annuities, also called equity-indexed annuities, ARE fixed annuities. Both the fixed and equity annuity are designed for conservative investors, but equity annuities can provide potentially higher rates of return than traditional fixed annuities.

An equity-indexed annuity offers a combination of traditional insurance product features, like a guaranteed minimum rate of return, and some features of traditional securities, such as returns linked to equity markets. Typically, an equity-indexed annuity is not subject to regulation by the Securities and Exchange Commission, but this depends on the combination of features provided in a particular plan.

Equity-indexed annuities, or EIAs, differ from traditional fixed plans in how interest is credited. In most cases, an insurance firm purchases an option in a particular index, such as the DOW or NASDAQ, and after a period of time, the option contract is due. At that time, if the market index has risen, the option is cashed in, with the interest credited to the annuity principal. If the market has decreased, the option expires without any interest being credited to the annuity account for the year.

Equity annuities are relatively new in the marketplace. They were introduced after the major stock market correction that occurred between 1999 and 2002 as a way to provide greater returns than traditional fixed annuity plans, but with greater reliability than a brokerage account.

What Investors Should Know

State insurance departments consider equity annuities to be fixed annuities. While the equity annuity account is not subject to the fluctuations of value experienced by variable annuity plans, an equity annuity does not function exactly like a fixed annuity either.

In actual practice, the annuity plan gains or maintains its value every year, and the investment cannot lose value as a result of negative market movement. All EIAs provide a minimum guaranteed return. Most equity-indexed plans also provide a fixed-interest account as an investment option as well, so when interest rates are high and the market is declining, this account could be used to credit interest to the principal annuity amount.

How Equity Annuities Perform

Equity-indexed annuities have historically provided average returns of seven percent or more. When the general markets perform well, the annuities do well too, and it is not uncommon for interest payments in good economic years to total between ten percent and 20 percent. And if the market drops rapidly, the value of these plans is evident, since they will maintain their principal and the interest earnings gained during past years.

Because of this, retirees who want safe and secure investments without sacrificing good interest rates favor equity-indexed annuities. These annuities offer significant peace of mind to investors, since they know that the investment value cannot decrease.

Agents and brokers like equity-indexed annuities because their returns are linked to market activity indexes rather than to individual stock or fund performance. This means they are not viewed as investment products by the Securities and Exchange Commission and not subject to its regulation.

Equity-indexed annuities provide a guaranteed minimum return and the safety of traditional fixed annuities, while offering potentially higher rates of return like a stock-market investment, but without the risk.

Before investing in an equity-indexed annuity, individuals should review the contracts carefully and note any surrender charges imposed for early withdrawals. These charges do decrease as the amount of time an insurance company holds the funds increases, however.