Interested in equity-indexed annuities (EIAs)? Be careful. The Financial Industry Regulatory Authority and the Securities and Exchange Commission have issued advisories about them, due to high hidden fees and other problems.

The sales pitch will often sound too good to be true. (Some salespeople earn commissions of 12% selling you these.) You may be told you can get the return of the stock market index without the risk of loss. Usually, there is a “guaranteed” rate of return. Your yield is typically based on an index, usually the S&P 500. But there is a “participation rate” that will lower your gain. For example, if your participation rate is 80 percent and the index returns 10 percent, your gain is only 8 percent (80 percent of 10 percent).

There are also caps that limit any growth to a predetermined point. For example, if the S&P 500 gains 25 percent in one year, many EIA investors may earn no more than 10 percent. Also, while the S&P 500’s growth rate includes dividends, many EIAs exclude dividend returns from the rate on which they base your payment.

With an EIA, your money can be locked up and inaccessible to you for many years, with early withdrawal penalties as high as 15 percent. EIAs are not insured by the Federal Deposit Insurance Corp. (FDIC) either. If the issuing company fails, you may be out of luck.

Meanwhile, when you buy an EIA, you forgo the now-favorable tax rate for long-term capital gains. Any gain in an annuity is taxed as ordinary income. A guarantee that many investors unexpectedly receive is that they will be paying the maximum tax rate with an EIA.

A good annuity can provide a lifetime income stream that can be a sound investment choice under the right circumstances. But there are many kinds of annuities, and equity indexed annuities seem to serve those who are selling them more than those who buy them.

Please call our office if you would like more information on the pros and cons of annuities.

Contra Costa Times 04/29/2012