Equity-Indexed Annuities Aren't Worth the Confusion

Equity-indexed annuities let investors have it both ways: They track the stock market's gains, but with less downside risk than an index fund or an exchange-traded fund. That's an appealing concept, particularly when there's so much concern about the housing market. But these insurance products also have some serious drawbacks.

Annuities are contracts between you and an insurance company: You make a single payment or series of payments, called premiums, and the insurance company periodically makes payments back to you. With a fixed annuity, the insurer guarantees the rate of return; with a variable annuity, the rate of return varies with the performance of the investment option you choose -- you could earn a higher rate of return than a fixed annuity, but you could also lose money.

Equity-indexed annuities are a kind of hybrid. They offer more upside, but also more risk, than a fixed annuity, but they have less risk, and also less upside, than a variable annuity.

The problem is that it can be extremely difficult to understand how much of an index's return you are giving up in exchange for the guarantee that you won't lose money. The methods used to calculate your return can be complex and differ from one insurer to another, making it difficult to compare products. Even more confusing, the method for calculating returns can change from year to year within the same policy, depending on the performance of the stock market. ...