The Investment Scientist

Equity Index Annuity (EIA) with Riders: Adding Insult to Injury

Posted on: February 6, 2023

Two months ago I wrote about the top ten reasons that Equity Index Annuities are ripoffs, but apparently I did not exhaust all possible ways an insurance company can get at your money. Recently, a client of mine asked me to review an EIA he bought two years ago. Oh my goodness! I have had my eyes opened and my heart disgusted once again!

The contract I looked at for my client put his money in a so-called “1 Year Average Participation Index Account” with an initial participation rate of 30% and a minimum participation rate of 10%.

Injury #1: With all EIAs, you give up the dividend, which is about 2% a year. So you need to plan to give up 20% in ten years and 40% in 20 years.

Injury #2: This injury stems from the word “average.” Let’s say in a given year, the market goes up 10%, you are not getting this 10% growth, you are getting the “average” growth. You have to read the whole contract to understand what a ripoff this term is. Let’s assume that in January, the market goes down 1%, and in subsequent months, the market goes up 1%. So adding all the gains together, for the whole year the market goes up 10%. The way they do the average is this: for every month, they will calculate the Year to Month Return, and then average them. The effect of this is to cut the annual return number by half. In a year the annual return of the market is 10%, after the insurance company applies their “average”, the return becomes 5%. See the table below for an illustration.

Injury #3: So at least you get a 5% return in the year the market rises 10% right? Unfortunately no. The actual proportion of the 5% that belongs to you is decided by the so-called participation rate. At the beginning it is 30%, meaning you only get 30% of that 5%. That comes to 1.5%. 

Insult #1: As if 1.5% is not low enough, there is the term “minimum participation” in the contract that lets the insurance company drop your portion to 10% of the 5%, meaning you may get 0.5% in a year when the market rallies 10%. As long as the insurance company credits your account 0.5%, it is fulfilling their contractual obligation. 

Insult #2: So now you have discovered that this product is a total ripoff and you want to get your money out. Fat chance that you can get your money out intact. The contract has a 14-year surrender period. This means that if you take your money out anytime during that 14 years, you will have to pay a stiff surrender charge. The first two years it is 20%. This literally means once you hand over your money to the agent, you have lost 20% of it right away. And you can not use any portion of your money during the next 14 years. What if you need some money to live on? What if you are sick, and you need the money for medical treatment? Alas, that’s where the riders come in.

Insult #3: If you want to take out some money for whatever reason without penalty, you can buy a so-called “income benefit rider”. For the privilege of using your own money, you must pay 1.5% per year as a rider charge!!! In other words, you have to pay them for the right to use your own money!!!

Insult #4: So you dutifully pay them 1.5% of your money every year so that you can use your money before the surrender period right? Yes, but there is a limit to how much one can take out even there. For couples in their 50s, they can take out just 1.5% for the whole year. They are paying the insurance company 1.5% so they are allowed to use up to 1.5% of their own money without penalty!!!

Schedule a 2nd opinion financial review, buy my wealth mgmt books on Amazon.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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