Equity indexed annuities sit in a complex place in the investment license world. It is far from obvious if these annuities require a simple insurance license or more licenses like the Series 6, 7, or 63.

To understand exactly what licensure is required, let's break down what these investments actually are and what circumstances require the various levels of licensing.

What are equity indexed annuities, anyway?
Equity indexed annuities are fixed deferred annuities tied to a market index like the S&P 500. Insurance companies guarantee a certain minimum return, limiting the investment's downside while still allowing the investor exposure to the market.

To sell these products, it is unclear if a simple fixed annuity license is required (a common license for insurance sales), or if a stock focused license like the Series 7 should be required. The product is offered as an insurance product, but at the end of the day it is an investment in the stock market. Even the governing agencies, the National Association of Securities Dealers, the SEC, and state insurance regulators, are not entirely clear.

When an insurance license is enough
Currently, regulators require at least an insurance license to sell these products in all cases. The logic is that because the insurance company bears the risk of loss, sales of the product should be governed by insurance licensing rules. For more specific requirements, you should visit your state's insurance commissioner's website for your state specific rules.

When more licenses may be required
Within that general requirement, there are exceptions. For example, if an investor wishes to purchase an equity indexed annuity with stocks, bonds, or mutual funds, the salesperson must also have either a Series 6, 7, or 63 as appropriate to sell those securities and reinvest the proceeds into the equity indexed annuity.

If, however, the investor wishes to fund the annuity investment with cash, another annuity, or cash value of a life insurance policy, then only an insurance license is required.

Buyers beware
At first, equity indexed annuities may look like a magic bullet with low risks and high returns. When used appropriately, they can be a powerful tool for rounding out your portfolio. However, buyers should proceed with caution when presented with this option by a salesperson. 

One problem is complexity. Equity indexed annuities are some of the most complex investments available to everyday retail investors. There is no standard structure either, meaning investors much pay attention each annuities participation rate, caps, spreads, margins, and asset fees. The participation rate is the percentage that the annuity will go up relative to the index it tracks. For example, a fund with an 85% participation rate tied to the S&P 500 will rise just $85 if the S&P rises 100 points. Investors can easily invest in one of these annuities expecting their investment to rise equally to the index, when in fact the gains could be substantially lower. 

This is compounded by a cap on returns that many insurance companies put on these annuities. So even if your participation rate is 100%, if the cap is set at 5%, that's the maximum you can gain in any given year regardless of the market's performance.

Further, the annuity's spread, margin, or asset fee are additional monies the insurance company will keep on top of the participation rate and cap. Similar to mutual funds, these fees can vary widely, with some set at reasonable low levels while others levy exorbitant charges.

Worst of all, insurance salespeople will oftentimes have luxurious incentives tied to the sale of these products. Beyond commissions that have been documented at north of 10% per sale, insurance companies have also offered exotic vacations, top of the line, jewelry and more. With so much to gain, even the most ethical of salespeople will feel the temptation to sell these products even if they are not the right fit for you. 

At the end of the day, you, the investor, must take responsibility for making the decision to buy an equity indexed annuity or not. If you do, make sure you fully understand exactly what you stand to gain, all of the fees, caps, and rates, and make sure that your advisor is recommending this product for you and not for a bonus.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at knowledgecenter@fool.com. Thanks -- and Fool on!