Lynn O'Shaughnessy

An elderly woman in my community learned not too long ago that she needed dentures. She had enough money to pay for the new teeth, but she discovered that her funds, while technically hers, couldn't be touched.

The bad guy in this pitiful case was an insurance company, which had capitalized on an ingenious way to make money off an easy mark.

What the woman with the bad molars had bought was an equity indexed annuity. Promoters attract unsophisticated investors by suggesting that buying an EIA is like owning a handful of magic beans and a golden goose. An EIA, they say, will allow you to enjoy stock market gains without any of the risks.

After listening to them, it would be easy to conclude that only a chump would continue to invest in mutual funds or individual stocks. If you put your money into one of these annuities instead, your EIA flak jacket will withstand all the nasty stuff that Wall Street tries lobbing at you.

In reality, however, EIAs aren't a miracle investment. And they certainly aren't risk-free for those who experience buyer's remorse. Hidden inside these things are incisors that can tear customers' investments apart if they decide they need the money.

EIAs are actually complicated insurance products that are being marketed to senior citizens who are terrified by stock market losses. The upside potential for EIAs, say the salesmen, is great, but if the markets crash, an EIA's return can't dip into negative territory. These annuities guarantee a base annual return, which is often 3 percent, for the length of the contract.

One drawback to EIAs is their complexity. While many EIAs are partially linked to the fortunes of the Standard & Poor's 500 Index, for example, there are plenty of ways that an insurer can shrink the annuity's return.

For starters, a customer might be promised a 50 percent, 70 percent or even 100 percent share of the S&P 500's annual performance. But that's misleading, because an EIA excludes the S&P 500's dividends as part of the return. Insurers also often put caps on the returns that you can capture. Just how much the performance will shrink can depend on which of the dozens of crediting methods that an insurer uses.

"There are probably 100 different ways to credit interest in an EIA, and you literally need a degree in industry methodology to understand," suggests Scott Dauenhauer, president at Meridian Wealth Management in Laguna Hills, Calif.

Critics contend that many of the best-selling EIAs rely on crediting calculations that provide customers with the most anemic returns.

Lynn O'Shaughnessy

Lynn O'Shaughnessy is the author of Retirement Bible.

Be the first to read Lynn O'Shaughnessy's column. Sign up today and receive delivered each morning to your inbox.