Equity Indexed Annuities, an interesting strategy...

Equity indexed annuities work like traditional deferred annuities in that they guarantee your principal every year and credit a certain amount of growth in the contract every year. The difference lies in how they determine growth. If the index they are marked to increases, they credit an amount relative to the increase. If the index decreases, remember these are still fixed annuities, so they don't lose value (though they may not gain value).

This is usually attractive to the purchasers of these contracts because they can participate in market upturns and stay out of market downturns. However, many people choose not to buy them because of long lockup periods (up to 20 years), surrender charges (up to 20%), caps on returns, and IRS treatment because they are essentially retirement accounts that shouldn't be accessed until age 59.5.

Is it possible to replicate the attractive features of Indexed Annuities without the negative drawbacks? Actually, yes.

For example, if you bought a zero coupon bond that would be worth $100 in one year for say $97, and bought a call option on the chosen index at the money at $100 for the remaining $3, you have replicated the positive features of the equity indexed annuity. This example assumes a lot regarding interest rates and option prices. The annuity companies get around these assumptions by creating floors that the index must achieve before crediting begins, and caps on crediting as well, sometimes limiting performance participation to 6% or less. After overcoming any difficulties in buying the options or getting the interest income on the majority of the principal, the annuity company pockets the difference.

If you can do it yourself, you can pocket the difference yourself as well.

Good luck!

Aaron