An indexed annuity (the word equity previously tied to indexed annuities has been removed to help prevent the assumption of stock market investing being present in these products) in the United States is a type of tax-deferred annuity whose credited interest is linked to an equity index—typically the S&P 500 or international index.
It guarantees a minimum interest rate (typically between 1% and 3%) if held to the end of the surrender term and protects against a loss of principal.
The objective of purchasing an equity index annuity is to realize greater gains than those provided by CDs, money markets or bonds, while still protecting principal.
The long term ability of Equity Index Annuities to beat the returns of other fixed instruments is a matter of debate.
As an example, consider a $100,000 fixed annuity that credits a 4% annual effective interest rate.
For example: Assume the index is the S&P 500, a one-year point-to-point method is used, and the annuity has an 8% cap.
The cap, 8% in this example, is determined by how much is afforded by budget which is usually at or near the 4% fixed rate.
Some longer term options are but have a "highwater" feature that allows interest to be credited more frequently.
An example of this would be a ten-year Monthly Average option that credits interest each year if there is a gain.
Crediting Components - the way the option is limited in order to reduce the cost (and subsequent return) so that it becomes affordable.
Also annuities do not qualify for a step in basis at the owner's death while most stock, bond and real estate investments are.