6 Crucial Questions to Ask Before Buying an Equity-Indexed Annuity

Are you being tempted by the promise of an Equity-Indexed Annuity (EIA) as a safe haven to invest your money, free from the risks of the stock market? It’s easy to be swayed by an agent who assures you that an EIA offers the best of both worlds: market-linked growth potential without the fear of losing your principal.

The emotional appeal is undeniable—after all, who wouldn’t want financial security with a chance for gains?

But before you make a commitment, you’ll want to know that many who have purchased these products later feel deceived and regret their decision. The reality is that EIAs often don’t live up to the way they are sold. They do however, do what they are guaranteed to do.

Purchasers frequently find themselves trapped in contracts that don’t perform as expected, with hidden fees, restrictive terms, and disappointing returns. The initial appeal can quickly turn into frustration when the realities of these products—and their true costs—come to light.

This article will guide you through the key considerations you should weigh before buying an EIA, helping you make an informed decision that aligns with your long-term financial goals.

Is your purchase part of a broader financial strategy, or is it being sold as a single product to eliminate the fear of losing money in the stock market?

When considering an Equity-Indexed Annuity (EIA), it’s important to recognize that no single financial product can address ALL your needs. If an EIA is being presented to you as a “catch-all solution” to eliminate the fear of losing money in the stock market while still capturing market-like gains, it’s time to pause and assess its role within your broader financial strategy.

Making financial decisions in isolation, without considering how they affect other areas of your financial life, typically leads to inefficiencies. These inefficiencies will force you to work harder to achieve your financial goals or, worse, compromise your long-term financial security.

There are situations where an EIA might be the right product, but using it as a safe haven alternative from stock market losses while hoping for stock market-like returns isn’t one of them.

Understand what is happening with your money – Insurance companies invest most of your premium dollars into a conservative portfolio identical to the one they use for regular Fixed Annuities. They use the income from the portfolio to speculate on the stock index they have linked the contract to. This is how they credit your account based on the performance of that chosen stock index. Because they use just the income generated by the conservative portfolio (the interest and dividends), they are able to guarantee, at minimum, a 0% credit which means you won’t lose money from the investment strategy even if the stock market dropped 99%! FIAs are insurance contracts, not an investment.

While the appeal of a minimum guaranteed return, even in a plummeting market, is attractive, it’s important to understand that the way these credits are calculated can significantly limit your potential for growth. In fact, EIAs often don’t outperform their fixed annuity counterparts over time.

Because an EIA is a fixed insurance product, the insurance company guarantees you won’t lose money due to market performance—hence the minimum crediting rate of 0% if the market were to drop drastically. However, this guarantee comes at the cost of stunted gains, meaning you will likely miss out on the higher returns that could be achieved with a little more market risk exposure.

I know “market risk” sounds frightening to a lot of people because it alludes to the potential of losing money in a stock market crash which isn’t acceptable. However, I would never advocate for anyone to put their money at risk in such a way where they could lose their ability to live the way they are use to. Instead, the type of market risk I am talking about is just enough so you can realize gains without caps so you can also eliminate other risks that could destroy your wealth, such as the risk inflation poses in destroying your moneys purchasing power because your returns are too low!

In fact, If you’re willing to accept just a bit of market risk, you could see returns that are 2-3 times higher over your lifetime, all without the fear of losing everything in a market crash…

Is your primary goal with this purchase lifetime income or accumulation of wealth?

When considering an Equity-Indexed Annuity (EIA) as part of your larger financial strategy, it’s crucial to identify your primary goal—whether it’s lifetime income or wealth accumulation. While these contracts are often marketed as vehicles for accumulating wealth, they frequently fall short of the promises made. In fact, EIAs might only slightly outperform regular fixed annuities in terms of returns. According to some sources, the average annual return on EIAs over the long term can range from 3% to 6%, which is often only marginally better than traditional fixed annuities.

On the other hand, annuities, being insurance contracts, are unique in that they are the only financial products that are contractually guaranteed to provide lifetime income. This guarantee is something no other financial product can offer, making annuities an attractive option for those who want to ensure they won’t outlive their money. The guaranteed lifetime income from an EIA is typically provided through a rider, which is an additional feature added to the contract. However, it’s important to understand that these riders are costs that eat into your contract’s principal, potentially diminishing the overall value of the annuity’s death benefit.

Another appealing feature of an EIA is that potential death benefit because it offers some financial benefit for your beneficiaries if you have money remaining in the contract when you pass away. However, other fixed annuity options, such as Single Premium Immediate Annuities (SPIAs), can also provide income payments and death benefits. The income benefits provided by regular fixed immediate annuities can be higher than what EIAs offer though because the insurance company has more control over the investments being made and can therefore back higher contractual guarantees. The point is, there are costs to provide benefits in EIA contracts.

Therefore, if the primary purpose of buying a EIA is lifetime income, it may be worth exploring other fixed annuity options that probably will provide both a higher income payment and death benefits.

I find many agents don’t present these solutions to their customers though. Maybe it is because the commissions are 2-3x less than they are with EIAs. If they do, they may underplay the benefit and “sell the sizzle” – i.e. – potential.

If you wouldn’t waste your money paying more premium for car insurance that provides a lower benefit than an alternative, then you shouldn’t waste your money buying this type of insurance when there are better strategies to maximizes your income and maximize your growth.

Are you comparing the contract guarantees with the current assumptions illustrated in the EIA?

When considering an Equity-Indexed Annuity (EIA), you will want to compare the contract guarantees with the current assumptions shown in the illustration. Agents might say these lower “guarantees” aren’t likely but don’t listen – look at what the contract says AND what could cause a lower rate.

Current assumptions are optimistic projections based on the best-case scenarios—what the insurance company “might” achieve if everything goes perfectly and they are making enough money for their owners. These assumptions often paint what I will say is a rosy picture to entice consumers to buy. These current assumptions are encouraging as they show you how much you could potentially earn under ideal market conditions. However, these are just that—assumptions, not guarantees.

On the other hand, contractual minimum guarantees are the bedrock of your annuity (insurance) contract. They represent the minimum performance and charges the insurance company is legally obligated to provide and charge, regardless of market conditions.

Here is a secret you may not have realized: insurance companies are not in the business of maximizing your benefits—they are in always the business of maximizing their owners’ earnings. This statement isn’t meant to be good or bad, it is just the way it is. This means that, while they may illustrate a scenario where you could earn significant returns, the insurance company will ensure their owners interests are prioritized over yours as a contract owner. That being said, they always have to provide you with what they have contractually guaranteed though. Again, EIAs are insurance contracts, not investments.

To increase their profits, insurance companies can change how they credit various contracts and increase charges your EIA annuity contract to ensure they can meet these guarantees and make money for their owners.

This flexibility allows them to protect their profits, which is their ultimate objective, even if it means your returns are far less than what you were led to believe. When you buy any insurance product, you must do so for the guarantees because the company is only obligated to fulfill what’s written in the contract—no more and no less. As nice as it would be to think otherwise, these companies are not altruistic. Their primary goal is to benefit their owners, not to maximize your wealth.

As you know, “The detail is in the fine print.”

Have you reviewed the historical 10-20-30 year returns to assess the opportunity cost and potential long-term wealth implications of choosing an EIA over other investments?

When considering an Equity-Indexed Annuity (EIA), it’s essential to understand the long-term impact of your decision. While EIAs offer a sense of security by protecting against market downturns, this safety often comes at a high cost—known as “opportunity cost.” By choosing an EIA over traditional stock market investments like a mutual fund based on the S&P 500, you could be leaving significant wealth on the table over the years.

Consider the following chart, which compares the growth of $100,000 over 10, 20, and 30 years under different scenarios:

EIA (7% Assumed Return)
EIA (3.5% Reduce with Contractual Guarantees Imposed)
S&P 500 (9% Historical Average)

Years	EIA (7%)	EIA (3.5%)	S&P 500 (9%)
10	$196,715	$141,060	$236,736
20	$386,969	$198,289	$561,060
30	$761,226	$278,006	$1,326,769

As the table illustrates, the S&P 500’s historical average return of 9% far outpaces both the EIA’s 7% assumed return and its 3.5% contractual guarantee. Over 30 years, the difference in accumulated wealth can be staggering, potentially exceeding $1 million when JUST $100,000 is used. Imagine how much those who pay in excess of $1M might lose.

This substantial gap highlights the “opportunity cost” of opting for safety over growth.

While safety and security are essential aspects of financial freedom, you’ll want to consider the long-term implications of your choices. Leaving potentially millions of dollars on the table is not being conservative and safe— I would say it is being kind of reckless. Of course if you don’t know any better, what can you do about it?

Since you are reading this, you can hopefully avoid this recklessness because it could threaten the financial freedom you hope to achieve in retirement.

Do you need the tax deferral benefits offered by an EIA, or are there other options that could serve you better?

One of the notable benefits of an annuity contract, including Equity-Indexed Annuities (EIAs), is its tax deferral feature. This can be particularly advantageous for individuals in high tax brackets, those living in states with high income taxes who plan to relocate to a lower-tax or no-tax state where they will eventually take income, and even for those who want to minimize the taxation of their Social Security benefits by reducing their taxable investment income.

However, before you buy any annuity, did you consider if you really need this tax deferral feature? Not surprisingly, many EIA purchasers buy these contracts within their Individual Retirement Accounts (IRAs), which are already tax-deferred, because they buy them as “stock market alternatives.” In such cases, the tax deferral benefit of the EIA becomes redundant, undermining one of the key selling points of the product. Also, the contracts distributions, whether during life or by the beneficiaries at death, are taxed at the highest marginal tax bracket which may be more than 50% of the contracts value!

if it is tax deferral you want, annuities are one financial solution. However, there are other financial products might offer more effective tax strategies depending on your specific needs.

For instance, life insurance contracts can be a better solution for those looking to accumulate wealth for estate planning purposes. Life insurance policies grow cash value on a tax-deferred basis, and the death benefit is 100% income tax-free to beneficiaries. The downside, however, is that you must be insurable to qualify for life insurance.

Additionally, investing directly in stocks or exchange-traded funds (ETFs) like a “SPDR” (NYSE:SPY), which track the S&P 500, can provide tax deferral on growth while living and a “step-up” in basis a death for estate tax purposes. This means that upon your passing, your beneficiaries could inherit these assets with a stepped-up tax basis, resulting in a tax-free transfer of wealth. Of course you have to manage the investment risk yourself when you invest directly into the stock market which is what you are probably trying to avoid by purchasing an EIA. However, there are investment strategies that will manage this risk without you having to sacrifice the upside potential. You just have to accept some market risk. So instead of having a “cap” on earnings, you put a “cap” on potential losses and are positioned for unlimited gains. How cool does that sound?

While EIAs offer tax deferral, it’s crucial to evaluate if this benefit aligns with your broader financial strategy or if other options could serve you better, particularly when the tax advantages of EIAs might be redundant or less effective than alternative strategies.

What are the alternative investment products or strategies that might work better for your financial situation?

When considering your financial future, it’s essential to recognize that no single product or strategy can address all your needs. A comprehensive financial plan should incorporate a variety of strategies tailored to your specific goals, risk tolerance, and life stage. This is where The Financial Freedom Process comes into play, offering a holistic approach that goes beyond the limited scope of any one product like an Equity-Indexed Annuity (EIA).

Our investment philosophy is grounded in the principle of protecting our clients’ wealth at all times. We believe in never putting all your assets at risk simultaneously. This means that if the market were to collapse, a significant portion of your wealth would remain safe, secure, and poised to capitalize on opportunities that others might not be able to seize.

As part of The Financial Freedom Process, I employ several key strategies, including INVEST, SALLO, and for those who have portfolios that exceed $500k, COINS. The INVEST strategy allows you to achieve full stock market returns with robust risk management, ensuring you can profit when the market soars higher with protection in place if it plummets. SALLO allows for additional benefits from you investments (like long-term care and life insurance) without reducing your portfolios return, while COINS is designed to generate additional portfolio income through a conservative options strategy, that also offers an additional layer of financial security and growth potential.

Rather than relying on a single product like an EIA, we encourage you to explore these alternative strategies as part of a broader, more resilient financial plan. My Financial Freedom Process is designed to help you navigate the complexities of investing with confidence, knowing that your wealth is protected and positioned for growth.

Take the next step toward securing your financial future by going through my Financial Freedom Process. Discover how a tailored investment strategy can provide the safety, security, and opportunity you need to achieve your financial goals. Reach out to us today to get started on the path to financial freedom.

The information provided on this website is for educational and informational purposes only and is not intended as financial, investment, or legal advice. Kevin Wenke, CFP, CLU, and his companies, Decision Tree Financial and Decision Tree Investment Advisors LLC, do not guarantee the accuracy or completeness of the information presented. No client-advisor relationship is established by the use of this website or interaction with its content.

All investments carry risk, including the potential loss of principal, and past performance is not indicative of future results. Decision Tree Investment Advisors LLC is a Registered Investment Advisory Firm and complies with all applicable laws and regulations. Kevin Wenke is also an insurance agent and may sell insurance products.

This website may contain links to third-party sites, for which we are not responsible for the content or accuracy. The content on this website is the property of Decision Tree Financial and Decision Tree Investment Advisors LLC and is protected by copyright laws.

For personalized financial advice, please contact Kevin Wenke or Decision Tree Financial directly.

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For personalized financial advice, please contact Kevin Wenke or Decision Tree Financial directly.

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