Broker Check

A Tutorial on Equity-Indexed Annuities

Tired of paying excessive taxes on investments, CD`s, even social security income? Scared of the stock market roller coaster? Can`t sleep at night due to the wild swings in your portfolio? Want some peace, guarantee of principle, guaranteed stock market gains but not the losses? Want to do asset allocation with some lifetime income guaranteed, regardless of anything and everything? Made too much money in the IPO, sale, merger or acquisition of your company, or the stock market, and want to have PEACE OF MIND moneys? Want to absolutely SECURE your future? Want to set aside moneys in trusts for your family? Want some "I will never be poor again moneys" set aside? Over age 59 1/2? Don`t have enough time left to go back to work or have the desire to work again? Simply want to save or invest for future retirement on a tax favored basis? One definition of RICH-"money makes more money equal or greater than what you need or can spend". Do you want your money to work for you? Do you want to pass on your moneys to your estate, family, children, school, church, temple or charity on a guaranteed basis? If you said "yes" to only one or many of these questions, or have thought about these issues, then Equity Indexed Annuities (EIA) may be right for you!! 

Let`s find out what these EIA are? 

Qn. What is an Equity-Indexed Annuity (EIA)? 

Ans. In the past few years, a new breed of deferred annuity has become very popular: the Equity-Indexed Annuity. Like other fixed-rate annuities, the equity-indexed annuity offers safety of premium, tax deferral, and a minimum interest rate guarantee. Unlike other fixed deferred annuities where the insurance company declares an interest rate for one or more years, with an equity-indexed annuity, the interest earnings are determined based upon the growth in an accepted equity index, such as the S&P 500 Index. There are many different formulas available to calculate the index growth, including calculating averages in index changes or simply calculating point-to-point changes in the index. Most of the current equity-indexed annuities use growth in the S&P 500 Index to determine the crediting rates. However, there are certain equity-indexed annuities which use the Dow Jones Industrial Average, the Russell 2000 or other indexes instead of the S&P 500 Index. In addition to tax deferral, equity-indexed annuities also offer safety of your premium. Equity-indexed annuity contracts offer a current interest rate linked to increases of an index or a minimum guaranteed interest rate (typically 2.5-3%). The minimum guaranteed interest rate is guaranteed regardless of what the Index does. The formula used to calculate the current interest rate is guaranteed by the insurance company. Thus your premium in an equity-indexed annuity is not subject to index volatility. Like fixed deferred annuities, equity-indexed annuities also have penalties for early withdrawal called surrender charges or withdrawal charges. These charges typically decline over the length of the surrender charge period (typically five to ten years). 

Qn. What is the death benefit on an Equity-Indexed Annuity? 

Ans. The death benefit on most equity-indexed annuities is the full contract value, i.e. your premium plus accrued gains compounded annually minus any prior withdrawals, calculated as of the date of death, or in some cases, as of the last contract anniversary. Sometimes, the death benefit amounts may also be lower or higher depending on the manner in which the payout options are chosen, usually lump sum Vs. payout over 5-10 years in some cases. 

Qn. Is there any way to avoid the surrender or early withdrawal charges? 

Ans. Yes. With most fixed deferred annuities, the surrender or withdrawal charges are waived if you (1) die; (2) become confined to a hospital or nursing home for a specified period; or (3) you choose to take a guaranteed income stream. In addition, most fixed deferred annuities allow you take up to 5-10% of your contract value each year or certain number of years, without incurring a surrender or withdrawal charge. See tax consequences of early withdrawals. 

Qn. How are Fixed Rate and Equity-Indexed Annuities taxed? 

Ans. If the annuity is nonqualified, i.e. purchased with after-tax dollars, only the earnings in the annuity are taxable as ordinary income. However, the taxes on the earnings are deferred until the time you actually withdraw the earnings. To the extent that there are earnings in the contract, the IRS considers any money withdrawn to be earnings. For example, let`s say you deposited $10,000 in a fixed deferred annuity, and five years later that deposit with interest had accumulated to be $15,000. In this example, the first $5,000 withdrawn is considered earnings by the IRS and is taxable as ordinary income in the year in which it is withdrawn. Because the IRS allows special tax-deferred treatment on annuities for the purpose of accumulating funds for retirement, any earnings withdrawn prior to age 59 1/2 are considered a `premature distribution` and are also subject to a 10% tax penalty in addition to ordinary income tax. If the annuity is qualified, i.e. purchased with before-tax dollars, any amounts withdrawn including premium and interest are subject to ordinary income tax in the year in which they are withdrawn. Again, all withdrawals made prior to age 59 �½ are considered a premature distribution and also subject to a 10% tax penalty in addition to ordinary income tax. 

Qn. How do I avoid the 10% tax penalty for premature distributions? 

Ans. Yes, there are no penalties on distributions: (1) If you are older than age 59 �½ (2) If the distributions are made on or after the death of the owner of the annuity (3) If you become disabled (4) If the distributions are made as a series of substantially equal periodic payments (not less than annually) for your life or your life expectancy or joint life expectancies of you and your designated beneficiary. (5) If the distributions are made under a single premium immediate annuity with a starting date no later than one year from the date you purchase the annuity. (6) If the distributions are made under certain annuities issued as a part of a structured settlement agreement. There are additional exceptions in the case of IRAs. Please contact your tax advisor for more details. 

Qn. What are the advantages and disadvantages of an Equity-Indexed Annuity (EIA)? 

Ans. The major advantage of an equity-indexed annuity over other types of deferred annuity products is potentially higher interest rates available from links to equity indexes, which historically have provided significantly higher yields than fixed interest rate products. The major advantage, of course, may be the major disadvantage also, particularly in periods of index volatility. However, all equity-indexed annuities have an underlying minimum interest rate guarantee which guarantees you will never lose your premium due to index fluctuations or volatility. Thus the equity-indexed annuity provides the best of both worlds-linkage to equity indexes with no risk, due to index volatility, and safety of premium.

The investor should understand that EIA's have a lack of liquidity, relatively high surrender charges over an extended period of time, often 9-10 years or more. Invariably, most insurance companies provide for a 10% surrender charge free withdrawal of principal per year.

Qn. Are all equity-indexed annuities designed in the same manner, or do they all offer the same features? 

Ans. Generally, each and every equity-indexed annuity product, even from the same company, will have different features, index crediting strategies, premium investment allocation options, participation rates, asset management fees, surrender charges, payout methods, annuitization options, etc. However, the concepts as discussed in the questions and answers above, explain in general as to how equity-indexed annuities work. 

Qn. How do I invest in an Equity Indexed Annuity? 

Ans. Please call us at (408) 836-3858 or send email to 

Annuities vs. Mutual Funds, Bonds and CD`s - A comparison

Mutual fund, Bonds and CD`s- unlike Annuity ownership- may subject Social Security or current income to additional taxation. 

Single taxpayers who have adjusted gross incomes of $25,000 or more and married couples with adjusted gross incomes $32,000 or more are subject to paying ordinary income taxes (on income) from 50% to as much as 85% of their social security income (check with your tax advisor). Mutual fund dividends, capital gains and bond income (even tax free bonds) and CD, and other savings such as money market interest, all count in the formula to determine adjusted gross income. 

Because earnings and interest earned in annuities are tax deferred, they do not count in the social security formula or current income taxation, for as long as it remains in the annuity. For those people then who have CD`s, savings accounts, mutual funds or bonds, then the question is, "are you still paying additional taxes on current income or Social Security income". If the answer is yes, then the question is, "how do you feel about paying unnecessary taxes". Then the next question one should ask is, "If I am not using the earnings to live on or survive, so why pay taxes on them as well as take additional risk plus pay annual maintenance, transaction and asset fees? Even if some investors were to take an income from such investments, then still an annuity investment may defer taxes on balance capital gains which are not withdrawn for immediate use. 

By repositioning these assets, you may be able to eliminate (or defer these earnings from current taxation, thereby reducing your tax bill) from the Social Security formula and possibly eliminate the taxes they are paying on Social Security Benefits. 


Jack and Mary are retired and receive Social Security benefits of $18,000 a year. 
Jack receives a pension of $20,000 a year. 
This income of $38,000 is enough for them to live on. 

They also have CD`s that total $200,000 and earn 4% for $8,000 income. They don`t spend this. 
They also have $100,000 of tax free Muni Bonds that earn 5% for another $5,000 income. They reinvest this income also. 

To see if they are taxed they must add one-half of their SS benefit, plus the pension, CD income and muni bond income together.(9,000+20,000+8,000+5,000) This total is $42,000. This exceeds the $32,000 limit for married filing jointly, so 50% of their benefit (50% of $18,000), $9,000 is subjected to taxation. 

Now, if we reposition assets that aren`t being used into fixed or equity indexed annuities, we could eliminate the Social Security tax or reduce current income taxes. Transfer CD`s and Muni bonds into an annuity (example- Odyssey for $300,000.) They eliminate $13,000 (of income they weren`t using) from the social security formula, thus lowering their income formula to $ 29,000. 

By making these changes you have eliminated the Social Security benefit from being taxed. You have also given the investor an option for fixed income and removed the risk of the bond portfolio dropping if interest rates rise. 

Another idea would be to use some of the CD money to fund a Single Premium Immediate Annuity in order to fund the premiums of a Long-Term care policy.

Investors should note that compared to EIA's, CD's enjoy FDIC Insurance and do not entail the substantial surrender charges applicable to EIA's. EIA's are generally backed by the reserves and bond portfolio of the insurance company. Additionally, mutual funds or bonds afford greater liquidity to investors. Unlike EIA's, mutual funds or bonds do not have lengthy surrender charges.

EIA's can have many moving parts in their interest earnings and crediting methodology, that can impact an investor's annual return, account value, income and growth. EIA's are fairly sophisticated financial instruments for long term retirement investing and short or even long term investing in an EIA for tax purposes "alone" is not recommended. Just like any other investment, all fees, expenses, surrender charges must be considered before investing in an EIA.

In contrast, CD's, mutual funds or bonds do not share the level of complexity of EIA's. The liquidity of CD's, mutual funds or bonds may be a major reason for investors to not consider investing in an EIA.

Therefore, when considering an investment in an Equity Indexed Annuity (EIA), all the above discussion and an investor's unique situation (income, health, estate, marital status, tax bracket,etc.), goals, current needs, time horizon, age, risk tolerance, proportion of that particular investment to their overall assets should be considered, before investing or sending any money. It is always the "suitability" of the investment that is the "golden rule". As always, for tax or legal questions, please consult with your tax or legal advisor.

For more information on taxation of Social Security Benefits, see Publications 554 and 915 at  

Call us today at (408) 836-3858 or send email to, for a personal consultation.