Can You Invest in Stocks Inside an Annuity?

Variable and equity-indexed annuities offer investors the ability to earn stock market returns.

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Annuities are financial instruments that are often utilized as part of a retirement plan. They are issued by insurance companies and guarantee specific benefits to the purchaser. Investors seeking to take advantage of market returns offered by stocks and equity indices can do so using variable and equity-indexed annuities.

Annuity Basics

Annuities are a form of financial contract that individuals purchase from insurance companies in exchange for a defined benefit, such as guaranteed income payments at a predetermined interest rate over a set period of time -- generally the life of the annuitant. They can be purchased in a lump sum or spread over time in scheduled or periodic payments. Immediate annuities begin disbursement right away, while deferred annuities begin to pay out at a pre-set date in the future. Individuals often purchase annuities as part of their retirement plan to secure lifetime payments, ensuring they don't outlive their assets.

Variable Annuity

Unlike fixed annuities that carry little risk and provide a fixed rate of return (typically little more than the rates offered with CDs), variable annuities afford investors the opportunity to increase their retirement savings through investment in the equity markets. While they don't allow direct investment in individual stocks, investors are can select and control (buy and sell at their discretion) shares of stock mutual funds that are held in the underlying account (referred to as the sub-account) of their annuity. The rate of return of the annuity is determined by the performance of the mutual fund shares held within the sub-account. Because of the inherent risk associated with the stock market, variable annuities are considered risky compared with fixed annuities.

Equity-Indexed Annuity

Another option available to investors is equity-indexed annuities (EIAs). EIAs are hybrid instruments combining aspects of both fixed and variable annuities. The purchaser is guaranteed a minimum fixed rate of return that is set within the contract (generally less than the rate offered in a fixed annuity), but they are able to earn additional interest that is linked to the performance of an equity index, such as the Standard & Poor's 500 stock market index. EIAs are generally capped at a maximum rate of return, such as 8 percent, regardless of the actual annualized return of the associated market index.

Additional Considerations

Annuities are considered long-term investments of a decade or more and often carry early withdrawal fees. Annuity contributions are not tax-deductible, as in an IRA account, but they do offer tax-deferred growth until distribution. Withdrawals by annuitants younger than age 59 1/2 are subject to the IRS early withdrawal penalty. Fortunately, gains earned within an annuity account are treated as ordinary income vs. those earned through direct stock investment, which are treated as capital gains. Unfortunately, the fees and commissions associated with annuities are often much higher than those incurred through direct stock investment.