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As with any investment, equity indexed annuities are suitable for some investors. EIAs are insurance products that appeal primarily to investors interested in safety of their invested principal. That is because a large annual gain is not possible from an indexed annuity, not only due to the participation rate, but also because these contracts typically have a cap, a maximum amount that the contract can increase in value in any one year, regardless of the performance of the index on which it is based.
Let’s look at a hypothetical indexed annuity, with a participation rate of 70% and a cap of 6%. What happens if the S&P rises 30%? The 70% participation rate of this 30% is 21%; however, due to the 6% cap, the contract’s value would increase by only 6% in that year.
To put this feature in perspective, let’s look at historical returns for the S&P 500 over 10 years, going back a few years now:
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 |
| 1.4% | 11.9% | 21.8% | -6.2% | 28.9% | 16.3% | 26.9% | 18.1% | 26.9% | 12.5% |
Going back to 2014 investors in an S&P 500 index fund had two years that were negative—2018 and 2022. Unlike in an ETF or other indexed fund, in an indexed annuity, the contract values would have, instead, increased by the minimum guaranteed rate both years.
On the other hand, owners of an indexed annuity would have missed out on the difference between the indexed annuity’s capped return and 11.9% in 2016, 21.8% in 2017, 28.9% in 2019, 16.3% in 20120, 19.4% in 2017, 28.9% in 2019, 16.3% in 2020, 26.9% in both 2021 and 2023, and 12.5% in 2024. That is a lot of growth to miss out on!
As we can see, the equity indexed annuity is suitable for an investor looking for a guaranteed minimum return. Investors looking for growth/purchasing power protection are better served in an index fund without any bells or whistles, whether an open-end fund or an ETF tied only to a particular index.