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If You Buy, You Might Pay Dearly

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By Martha M. Hamilton
Sunday, October 7, 2007

They sound too good to be true.

First offered in 1995, equity indexed annuities have attracted buyers by seeming to offer the best of both worlds -- the possibility of high returns when the stock market is booming and a guarantee to protect you in hard times.

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"Conceptually, the idea makes sense," said Moshe Milevsky, a finance professor at York University in Toronto and an expert in financial risk management. "In practice, they've destroyed a lot of the value."

Many buyers have come to regret buying on the promise without understanding the potential pitfalls. Regulators have issued repeated warnings about the way in which equity indexed annuities have been sold.

I've spent a lot of time in the past two weeks talking to people and reading about equity indexed annuities. The upshot? I wouldn't buy one.

First, let's talk about the product. Then I'll share with you the concerns regulators and others have about how it works.

The equity indexed annuity is an insurance product. You pay premiums for the promise of payment at the end of an agreed-upon time period. That's the annuity. The amount to be paid is based either on the performance of an index, usually the Standard & Poor's 500-stock index, or a guaranteed minimum return.

The equity indexed annuity has multiple features that vary from plan to plan. For instance, S&P 500 performance can be calculated in different ways. Also, gains can be capped at different percentages. And there are still other factors that determine how much an investor gains. To compare, you need to understand how all those features work together.

Also, the investment is not actually an investment in stocks, so you receive no dividends. As a study by the Securities Litigation & Consulting Group noted, dividends have historically accounted for 20 percent of the returns that investors in the S&P 500 stocks have earned.

So it's important to understand what you're buying.

If you need to withdraw money early, you can face substantial charges called surrender fees. In some cases, the fees may be big enough to eliminate any return on investment, according to a 2005 investor alert by securities regulator NASD (now the Financial Industry Regulatory Authority, or FINRA).

Regulators and others have heard a lot of horror stories recently from investors who bought these products without understanding their limitations.


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