Q. Jeff, I've been approached by someone touting the benefits of equity indexed annuity with "Company-X". They say my money will be safe, there's a minimum return and a cap with a participation rate of 100%. They also said I'd probably average between 6%-7% without any risk to the money I put in. I'm confused by all this. Any help you can give would be greatly appreciated!

A. I'd be happy to help. It's completely false when they say you should earn 6-7% per year without any risk. The only 'guarantee' on any equity-indexed annuity is the guaranteed minimum rate. On Company-X's equity-indexed annuities, their guarantee is 3% on 75% of premium.

As you can tell, they aren't interested in making equity-indexed annuities easy to understand. 3% on 75% of premium means that you are only 'guaranteed' a minimum of 2.25% on the full amount you invest. If you put in $100,000, they'll pay you 3% on $75,000, or $2250 in interest.

Why don't they just say they'll pay you 2.25%?

The rest of the 6-7% return they say you should safely earn is entirely based on the stock market. More correctly, you are guaranteed of earning 2.25% if you leave all of your money in the equity-indexed annuity for 10 years. Any additional earnings are subject to the performance of the stock market.

They aren't even straight with the market-based returns. You either have the option of "yield spread deducted from average monthly positive gains or cap with no spread ".

The Spread Option: Your contract is broken into monthly periods and the return for each period calculated. That gives you 12 one month returns. Those are added together and divided by 12. Lastly, the 'spread' is deducted from that average.

I don't know what their spread is (and they can change it anyway), but if it were 3%, they'd then subtract 3% from the average I just mentioned. Let's say your average was 7%. 7%-3%=4%. So they'd credit you 4% for that contract year.

The 100% option: You get 100%, but only up to the cap, say 9%. So if the index goes up 9% you get 9%. If it goes up 23% like in 2003 you still only get 9%. And they can change the cap.

The bottom line is that you're locked into an equity-indexed annuity and they control everything. They can change how your return is calculated from year to year and you have no recourse.

Q. You stated they can't guarantee 6-7% as my return, but that the return would be based on the average of the S&P 500. What was the average for the last ten or so years? And wouldn't that be my return? Company-X has a 100% participation rate and that sounds good, but they said there is a 7% cap on the interest rate. That sounds pretty decent in comparison to what I can get on a fixed annuity. What do you think?

A. As of 2/18/2005, the 10 year average annual return of the S&P 500 was 11.5%. You participate 100% but only up to the cap--7%. For instance, in 2003 the S&P 500 earned 23%, but this EIA would have only earned 7%. Last year, the S&P 500 earned over 10% with dividends reinvested. This EIA would have only earned 7%.

That's a huge difference. $100,000 earning 7% for ten years will be worth $196,715. The same investment at 11.5% will be worth $217,852. That is $21,137 more. Put differently, you will earn 21% more over ten years at 11.5% then at 7%.

You shouldn't compare an equity-indexed annuity to a fixed annuity. A better comparison would be to a variable annuity because none of the returns of a fixed annuity are subject to the stock market.

I don't have any financial incentive in the advice I'm offering you. On the other hand, the person recommending the equity-indexed annuity will probably make a 10% commission and will provide little or no service after you sign you up. Did they mention that?