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Equity Indexed Annuities (EIAs) have become the hot product of late. I believe you can easily find other alternatives that will bring a better return, without locking up your money or levying hefty surrender penalties. I’ll discuss these alternatives in the next two articles. But first, you should understand two things: your purpose for investing and how EIAs work.

Know why you’re investing. For simplicity let’s consider two objectives–stability and growth. If you are primarily concerned about protecting your investment and earning a stable rate of return then your main objective is stability. On the other hand, if you are concerned about protecting yourself from rising prices, building a retirement nest egg or growing your wealth then your primary objective is growth.

It’s unlikely that your objective will be 100% stability or 100% growth. Usually it will be a combination of the two. For instance, if you’re 55 years of age and preparing for retirement, perhaps you’d want about 40% of your portfolio invested in ‘stable’ investments such as bonds or CDs, and 60% invested in equities such as stock mutual funds.

On the other hand if you’re 75, stability may be more of an issue for you. You still want to plan for inflation, but your objective is very different from a 55 year-old. You might have 70% in stable investments and only 30% of your money in equities.

Maybe you’ve been told EIAs are the perfect answer. They’re sold as delivering both stability and growth. Salespeople say you can participate in the growth of the stock market without the risk, while always earning a minimum of 3%. It seems that an EIA will help you meet both objectives. Upon closer examination, though, you will see that it doesn’t do either very well.

EIAs are said to provide stability because they provide a minimum return of 3%. Let’s put that in perspective. In return for that 3% minimum you are required to keep YOUR money in the investment for many years, or else pay a penalty that in some cases could be the equivalent of over 3 years worth of return!

Moreover, that 3% minimum doesn’t change over the long length of the investment. If interest rates increase during those 7 to 12 years, you will be unable to take advantage of them. Imagine how you would feel if you knew you could be earning 5% or 7% in a CD or government-guaranteed bond, but you were stuck in an EIA paying 3%! The stability an EIA provides just doesn’t measure up.

So let’s take a closer look at the growth offered by an EIA. Typically, your investment choices are limited to the S&P 500, NASDAQ, or a bond-related index. But EIAs place a limit on how much you earn. If these indexes go up 25% or 50% like they did in 2003, you may only earn 10% to 12 %.

EIAs only allow you to only participate in a portion of the index’s return, or they have internal charges of 1-2%. Even if the underlying index goes up 10%, your return will be lower. This makes sense when you realize the insurance has to earn back the enormous commission it paid the agent. The insurance company can’t pay a 3% minimum in the bad times AND allow you to get 100% of the return in the good times.

So, in an EIA, you bear the risk of investing in the stock market but don’t get all the return. Don’t stack the deck against yourself. When you invest in equities you should have access to thousands of choices, and get all the return.

The bottom line: why trap yourself in an investment that greatly limits your upside potential and shackles you with outrageous surrender penalties, all for a measly 3% promised return, while your agent walks away with a 10 or 12% commission? No matter how you need to split your portfolio between stability and growth, believe me, there are much better ways to manage your money. I’ll talk about them next week.

What are some of the benefits you can get by investing in fixed indexed annuities? Well one thing is you may be able to help save up for your retirement with triple compounding interest, and have it grow about 2-3 times greater than a bank CD. They can also provide a guaranteed income for life, and with so many things happening in the world, it’s hard to imagine that social security will be around for much longer. So wouldn’t it be smart to have a back up plan to replace a potential social security income? They can also be a good option if you are in the middle of a 401k rollover.

In the past many people had a choice of getting a safe way of making money, but not the chance of higher returns. Or they could try for those higher returns, but would also run a risk of losing a lot of their principal investment. However, with fixed indexed annuities you have a shot at both without putting your principal at any risk! Offering you a guarantee for the principal, but also a link to the market, however, even with those downturns in the market, you wouldn’t lose principal.

Fixed indexed annuities may also be termed equity indexed annuities. They will provide you both features in one, a guarantee for that principal. But you can also see a fluctuation due to the market performance, but you will never lose any of your principal. You also lock in any gains that you earned in a certain period. It’s definitely a solid option when you are doing a 401k rollover.

The great thing also about a fixed indexed annuity is that you can defer taxes until you’ve taken the money out. That means you will be able to build up more money because you can earn more on the interest. But they also can offer you at times where you can take out a certain percentage of money without a penalty being paid, usually up to 10% per year. Most other IRA’s don’t allow that.

With the purchase of fixed indexed annuities you will be able to have a guaranteed income that will come in for the rest of your life. There are many different annuity payments that you can choose also. It gives you plenty flexibility and is a great option during an IRA rollover or 401k rollover.

Fixed indexed annuities are possibly one of the best options when it comes to saving for retirements. It is definitely something that is well worth your time of looking into. The fixed indexed annuities definitely have a place in today’s volatile market, especially during a 401k rollover.

Fixed Indexed Annuities might have been saved from Securities & Exchange Commission (SEC) regulation when the United States Congress accepted the Harkin Amendment in the “Restoring American Financial Stability Act of 2010.” These complex insurance instruments had been the source of controversy when the SEC attempted to grant itself regulatory jurisdiction on December 17, 2008 under Rule 151a. Whenever, there are economic problems, government bureaucrats are quick to attempt to acquire more territory to increase the size of their fiefdom.

All agree that annuities are complex financial instruments, the difference of opinion rests in whether the states should continue to regulate these as “insurance” instruments or the SEC should regulate these as “security” instruments. Oftentimes, monumental economic collapses, like the Great Depression, have led to a reassessment of how the system could be run more efficiently. Government regulation of financial companies has become an issue for many citizens.

Recent Financial Adjustments May Have Caused More Harm Than Good

Along with the November 12, 1999 repeal of the Glass-Steagall Act of 1933 and the extremely liberal lending practices of Fannie Mae and Freddie Mac, there were a number of governmental actions that added to the recent economic meltdown. When the SEC adopted rule 151a on December 17, 2008, they argued that because fixed indexed annuities were so complex and the value of these annuities was linked to securities, consumers needed added protection for these “securities.” The SEC acted as if this action was meant to better protect consumers after the subprime mortgage crisis.

One of the worst characteristics of government bureaucracies is their tendency to acquire more-and-more power in their hands, when left unchecked. SEC Commissioner Troy Paredes (who was the only dissenting vote against adopting rule 151a on December 17, 2008) warned that Supreme Court law defined fixed, indexed annuities as insurance products, not securities. He stated, “… our jurisdiction is limited; and thus our authority to act is circumscribed.” He warned of the slippery slope – once the SEC disregarded the law on one product, it was more likely to ignore the law on other insurance products.

D.C. Court of Appeals Vacates Rule 151a

On July 12, 2010, the United States District Court of Appeals for the District of Columbia had determined that the SEC does not have the authority to regulate fixed indexed annuities, therefore, they “order that Rule 151a be vacated.”

Harkin Amendment to Nullify Rule 151a

Senator Harkin argued that the D.C. Court of Appeals was in the process of vacating Rule 151a, therefore the nullification of this rule should be included in the Financial Regulatory Reform Bill. The Harkin Amendment confirmed that fixed indexed annuities are insurance products that should continue to be regulated by the states, not the SEC. The House-Senate Conference Committee voted to approve the Harkin Amendment on June 22, 2010. When the Harkin Amendment officially becomes law it will be great news for the annuity industry.

“Restoring American Financial Stability Act of 2010″

Government bureaucrats hate taking responsibility for anything. Unfortunately, when economic catastrophes occur, they try to take advantage of problems in order to grant themselves even more power and authority. They argue that they failed because they didn’t have “enough power.”

A true democracy demands that citizens hold their government accountable. Common sense, rationality, and legal precedents must rule unless there is a compelling reason why they should be changed. The SEC never offered a compelling reason for adopting Rule 151a. Citizens must continue to keep their pressure on their representatives so that annuities will remain safely out of the SEC’s claws.

I am always amazed about the questions I get from agents regarding the types of annuities available. Annuities come in many shapes and sizes each designed for a specific use. One annuity may have benefits another does not and it is important to know the features and benefits of each contract.

Single premium deferred annuity: As the name implies it is a one time deposit and no further deposits are accepted. A single premium annuity can be many different types such as a fixed annuity, an indexed annuity and a variable annuity. Each of these types of single premium deferred annuities has their own features and benefits. I will discuss each of these later.

Flexible Premium Deferred Annuity: This type of annuity allows for continual or sporadic additional deposits. Each deposit is added to the account value and can be deferred. Variable, indexed and fixed can all be flexible premium annuities.

Single Premium Immediate Annuity: These contracts are used to create an income stream. A single deposit is made and an income will begin at a
pre-agreed upon time. These payments to the annuitant can be monthly, annually or most other time periods. Any time period for the payout can be selected from any number of years to a lifetime guaranteed payment.

Variable Annuity: Variable annuities are securities and are sold with a prospectus. Variable annuities allow for the annuitant to designate a specific type of sub account or investment for the funds to be invested in. These sub accounts are like mutual funds in the sense the money is managed by an outside source and there is no limit to the growth of the funds or the exposure to loss. The money in the variable annuity is not at the insurance company but is on deposit at the fund manager. Variable annuities do have a guaranteed rate of return section which usually is a lower rate of interest. Variable annuity owners may switch investments in the annuity in the event of a new investment goal is desired. These changes can be completed without any tax liability. The funds in a variable annuity are not guaranteed and exposure to loss is part of the investment risk. In the event of death, variable annuities will guarantee at least the return of the original investment in the event the account is lower.

Indexed Annuity: Indexed annuities are fixed annuities whose returns are set to an outside source such as the Dow Jones Average. The funds in an indexed annuity are on deposit with the insurance company and not actually invested in the indexes. There are numerous options for selecting the type of crediting rate and how it interfaces with the specific index. One strong positive about indexed annuities is the deposit is fully guaranteed to never lose money and once a new amount is credited to the annuity then that becomes the guaranteed minimum.

Fixed Annuity: Fixed annuities come in all sorts and sizes from a few years contract to a longer period. Some will fully guarantee the interest rates the entire time period while others will allow the insurance company to determine the interest credited year to year. The funds in a fixed annuity always have a minimum interest which is fully guaranteed. Fixed annuities also guarantee the full account value.

Annuities are not for everyone but for those that will benefit from these contracts they can be perfect. Safety and security is the basic attraction to an annuity and when these benefits are needed they can be of enormous value. Developed your expertise, understand which annuity products are right for the unique circumstances and needs of the investor and increase your annuity sales.

There is considerable discussion about whether you should consider annuities good or bad. The short answer is that it depends. You’ll need to go a little further to really answer the answer to the question: are annuities good or bad?

What the Experts Say:

If you do any reading about annuities online, you’re likely to find many articles that criticize annuities. The criticism tends to focus on high fees and low returns. Some financial websites like The Motley Fool come right out and scorn annuities as investments, but even they must admit that, in some circumstances, certain kinds of annuities have a place in an investor’s retirement portfolio. The reason for this is that a lifetime income annuity will help you to ensure that your retirement savings will not run out during your lifetime.

The critics at Motley Fool categorize the different varieties of annuity plans as “sometimes good,” “bad,” and “ugly.” In their opinion, equity indexed annuities are the worst, variable annuities are bad, and lifetime income annuities are “sometimes good.” The opinions of financial professionals about these plans vary greatly, however. They recognize that each investor’s situation is different; what is a “bad” plan for one individual may be the perfect solution for another. That said, let’s focus on lifetime income annuities.

Lifetime Income Annuities:

Annuities don’t come anymore basic than lifetime income annuities. With the lifetime annuity contract, you pay a lump sum to an insurer in exchange for receiving a specified amount of income on a regular basis until you die. These plans do not offer the potentially high returns of investments like stocks and bonds, but a good lifetime income annuity plan provides a cost-effective way for you to not outlive your money. These plans are appropriate for individuals who are close to retirement and who don’t have as much in their retirement savings accounts as they would like. The plans are also suitable if you don’t want to deal with a financial advisor when managing your investments in retirement.

Do Your Financial Homework:

Annuities are frequently sold as the best retirement products on the market. Conversely, they are criticized as being the worst possible choice for investors. The truth is somewhere in between and completely depends on what you want. If you are willing to assume high risk to get potentially high returns, you’ll probably want stock and bond investments. However, if you are a conservative investor and don’t want to outlive your retirement savings, take a look an annuities. They may just the thing for your particular needs. And always consult a trusted financial adviser before buying any investment plan.

Equity-Linked Certificates of Deposit are a safer, low-cost alternative for those who must have an Equity-Indexed Annuity type of investment. These little-known investments allow you to participate in the growth of the market index while your principal is guaranteed by the Government. Read on to find out more.

Equity-Indexed Annuities are probably the most heavily promoted investment for seniors in today’s marketplace. The sales pitch is appealing and the payoff to the agent is very big–up to 13%. The enormous commissions have led to sales abuses which leave seniors holding the bag.

Readers of this column have wised up to the flaws of Equity-Indexed Annuities. But what are the alternatives?

The best alternative to Equity-Indexed Annuities is to use a diversified mix of investments and strategies that can provide an income stream between 6% and 10% while limiting any risk of significant loss. That’s what I do for my clients–without long-term time commitments or surrender penalties if they want access to their money.

Another alternative is called an Equity-Linked Certificate of Deposit. They provide virtually all the benefits that Equity-Indexed Annuities are designed to provide, without all the negative strings attached.

Equity-Linked Certificates of Deposit are offered by banks. They pay a return that is based on a stock market index, usually the S&P 500. Just like all Certificates of Deposit, they are federally insured by the FDIC up to $100,000 per individual. The minimum purchase for an Equity-Linked Certificate of Deposit is usually $25,000, but some can be found with $1000 minimums.

The return is based on the average performance of the S&P 500 over a set period of time. Just like Equity-Indexed Annuities, how the return is calculated depends on the issuer. The returns are all based on averaging the gains or losses of the index at set points over the life of your contract. Some Equity-Linked Certificates of Deposit guarantee a 3% return. Those doing so will limit the index return. Others provide 100% of the calculated index return.

The only way you can lose your principal with an Equity-Linked Certificate of Deposit is if you pull your money out before the end of the term. Most will have some form of a penalty, but since there wasn’t a big commission paid to an agent to sell it, the redemption penalties should be small. (Some don’t allow early redemption so investigate before you invest.) All allow early redemption without penalty if the account holder dies.

One of the major benefits Equity-Linked Certificates of Deposit have over Equity-Indexed Annuities is a short term commitment, FDIC insurance of principal, and much lower fees. They allows you much more control and flexibility.

For instance, let’s say you intend to invest $75,000 in Equity-Linked Certificates of Deposit. Instead of putting all the money in a single CD, divide that money between three–purchasing one each year for three years. Then as one comes due you can roll it into another 3-year term. This will reduce the negative effects in how the index returns are calculated while giving you access to $25,000 every year.

There are several disadvantages to Equity-Linked CDs. They don’t normally pay interest until maturity, so these investments are not a good choice of those looking for steady income. And like Equity-Indexed Annuities, you don’t really get 100% of the market gains because of the averaging used in calculating the rate of return.

You may be wondering why you haven’t heard of Equity-Linked Certificates of Deposit before. In fact, you should wonder why the advisor recommending you buy an Equity-Indexed Annuity hasn’t recommended them! The reason is they don’t pay a large commission so there isn’t a financial incentive for the advisor to do so.

Check with your local bank to see if they offer Equity-Linked CDs. Not all do, but they are becoming more widespread. Any broker or advisor that can sell bonds should also have access to Equity-Linked CDs.

I still believe there are better ways to invest your money than Equity-Linked CDs. But I’d much rather see someone invest in them than an Equity-Indexed Annuity. Don’t let advisors who stand to gain so much from your money pressure you into investing in an Equity-Indexed Annuity when an Equity-Linked CD is a much better alternative.