Choosing a suitable vehicle for your retirement is not an easy task. With the numerous choices, which product is better suited for your needs? On one hand, you might want the guarantee of principal and past earnings. On the other hand, many prefer the potential of higher returns by being linked to the equity markets.

Would you like an annuity that tracks the performance of the stock market, yet helps to protect your principal when the market declines? The equity-indexed annuity could help you to cover these objectives.

The equity-indexed annuity can offer some market risk protection, tax-deferral, a minimum interest rate guarantee, probate savings, and guaranteed minimum income payments for life. The interest earnings for these annuities are based upon the growth in an accepted equity index, such as the S&P 500 index, Dow Jones Industrial Average, and Russell 2000. The interest rate applied to these annuities is based upon the overall movement of the index.

Many of these annuities will base the interest rate upon a pre-determined percentage of the market movement. For example, let’s assume for illustration purposes that the annuity company set its participation rate at 50% of the index movement of the S&P 500. Let’s assume that the S&P 500 had a good year and increased by 30% (this is a hypothetical assumption and is not based upon the performance of any particular investment). Let’s also assume that the interest rate could actually move as high as 15% before any rate limitations were applied. Based upon the facts of this example, the interest rate that would apply to this hypothetical account would be 15% (before contract fees and expenses are subtracted from the account balance). Please note that participation percentages do vary among companies and can range anywhere from 80% to 100%. Some companies also set a cap on the interest rate, which can vary from company to company (typically between 10% or less).

The second fundamental feature of these annuities is the market risk protection. In the event that the market index should go down, this feature will help prevent your principal investment from being reduced below a certain percentage of your principal investment. The minimum guaranteed account value typically can also vary among companies and generally ranges anywhere from 75 to 100% of your premium, depending upon the type of product involved.

Notwithstanding the benefits previously discussed, there are many other things that should be considered before a purchase is made, including:

1. Surrender Fees. Like fixed deferred annuities have penalties for early of the withdrawal called surrender charges. These charges can result in a loss of your principle investment (see discussion below on withdrawals). These charges typically decline over the length of the surrender charge period (typically 5 to 15 years, depending upon the company).
2. Tax Consequences. These annuities are also suites for investors with long-term investment horizons. Withdrawals from these annuities prior to age 59^1/2 can also subject the annuity owner to income taxes and an additional 10% income tax penalty on the distributed amount.
3. Features Vary Among Insurance Companies. There are many companies that are offering these types of annuities, and methods of calculating the minimum and maximum interest rate vary greatly among them. Although many companies offer a minimum interest rate (typically ranging between 1.5 to 3%), some companies offer minimum interest rates as low as 0%.
4. Fees and Expenses. Asset management fees will be incurred on these annuities. Maintenance fees, sales commissions, trading costs and other contract charges could also apply. These charges will, in many cases, reduce the account value of these annuities.
5. Loans and Early Withdrawals. Although some companies do allow you to take minimal withdrawals without surrender charges, it is important to remember that some withdrawals can affect the amount of market downside protection provided under the contract.
6. Company Stability and Regulatory Oversight. All annuity features are guaranteed by the claims-paying ability of the issuing company. Please note guarantees associated with an equity index applies only if the annuity is held until the end of the contract term and that loss of principal is possible if the annuity is surrendered before the end of the contract term. Despite the market participation feature, the various state insurance departments regulate these products.