What is an Indexed Annuity

An indexed annuity is a complex financial product. It is a type of contract between an insurance company and the investor where the company promises to provide returns linked to the performance of a market index such as the Dow Jones Industrial Average or the S&P 500.

In the typical annuity, the investor makes a series of payments to the insurance company, or a lump sum payment. The investor allocates the payments to an index, and the company credits your account with a return that is based on that index. The company also protects the investor on the downside and provides for a minimum interest payment, typically 3% a year.

While this sounds great, the insurance company caps the amount of gain credited to the investor’s account. The details are different for every annuity, but there is always a cap on the gain. For example, an insurance company may credit only a portion of the gain in the index, or all of the gain up to a certain percentage. If the index gains more than the cap, the insurance company keeps the excess. If the company only credits a portion of the gain in the index, it keeps the difference. Some annuities have both limitations.

Not all indexed annuities are regulated by the SEC. The SEC regulates only annuities that are securities. These annuities can expose investors to investment losses. If the indexed annuity is a security, generally a prospectus will be delivered to you.

Before purchasing an indexed annuity, you should ask your financial professional what type of indexed annuity it is, what risks are involved, and about any expenses such as commissions and other fees you will have to pay. If the annuity is based on a security index, you will receive a prospectus, which you should review carefully.

The SEC has an Investor Bulletin which explains indexed annuities in greater detail – Investor Bulletin – Indexed Annuities