Beware the Equity Indexed Annuity

Economists are fond of saying that there is no such thing as a free lunch. Investors often interpret this enduring truth to mean that the quest for higher investment returns is necessarily accompanied by increased risk. Fair is fair, after all.

This long-accepted tenet of investing notwithstanding, certain corners of the financial services industry have begun to pitch a relatively new product that may appear to defy our financial laws of physics. Although it is marketed under a variety of imaginative names, the product is generically known as the equity-indexed annuity. It is a complex, highly-engineered product whose returns are linked to the returns of the stock market to some extent. In general, an equity-indexed annuity is a cross between a fixed annuity and a variable annuity.

Increasingly, these annuities are being pitched to prospects who are invited, en masse, to a restaurant for a portfolio review and – you guessed it – a free lunch. To receive the free lunch, however, prospects are usually required to prove they can meet certain investment minimums. Sometimes, they are told to bring their bank and brokerage statements directly to the restaurant as a sort of admission ticket.

The marketing hype associated with annuities in general tends to focus on various guarantees while glossing over other important realities such as high expenses, penalties, fees, surrender charges and the often arcane methods of crediting interest. Annuities also have certain tax and estate planning drawbacks.

So, if you’re tempted to accept an earful of annuity along with a bellyful of chowder, you would do well to remember the old adage, "The bold print giveth and the fine print taketh away."