All signs point to the possibility that fixed indexed annuities may once again be poised to become the hottest product in guaranteed lifetime income planning.
In general, fixed indexed annuities provide protection against loss of principal while pegging growth to a major index, such as the S&P 500. Clients tend to like the idea of participating in market gains while also protecting their principal and locking in a stream of income during retirement. However, indexed annuity sales have faltered in recent years due to the attention the DOL and other regulatory bodies have given to these products, which have historically been sold on a commission basis.
With the demise of the old DOL fiduciary rule and other emerging rules, however, it looks like fixed indexed annuities might be making a comeback—meaning that advisors may once again find themselves fielding questions about new developments in this product area.
Fixed Indexed Annuity Trend: Need to Know Product Information
Unlike directly investing in the equity markets, fixed indexed annuities offer principal protection in exchange for limitations on the potential for investment gains. However simple that initially sounds, these products usually contain complex features that the client will have to evaluate. When purchasing the annuity, one of the most important choices for the client is the interest crediting method, which essentially determines the way interest is credited to the account value.
The annual point-to-point interest crediting method is a popular option because of its simplicity—the beginning index value is compared to the ending index value on the annuity’s (annual) anniversary date, and the percentage of change is calculated. If the ending value is higher, the client generally receives interest, and if it is lower, no interest will be credited.
Often, fixed indexed annuities also include a cap or a spread. A cap, as the name suggests, serves to cap the client’s credited interest at the cap amount (i.e., if the index gained 10 percent and the cap is 6 percent, 6 percent will be credited, but if the gain was 1 percent, the client would receive the 1 percent credit because it is less than the cap amount). A spread is subtracted from the value of the gain—so if the index gained 10 percent and the spread was 5 percent, the account would be credited with 5 percent interest. If the index gained only 1 percent, no interest would be credited because the spread is greater than the gain.
Other crediting methods (such as the high water mark method or point-to-point method) often do not credit interest until the end of the investment term. If this is the case, a decline in value near the end of the term can cause a loss of earlier increases in value.
What’s on Horizon for Future Fixed Indexed Annuities
The Setting Every Community Up for Retirement Enhancement (or SECURE Act) was recently passed in the House and provides a safe harbor rule designed to address employers’ concerns with annuity investment offerings and fiduciary responsibility. Because this fiduciary issue was one of the primary concern that many employers have had with offering annuity options within the 401(k), it’s expected that annuity options in 401(k)s will become much more popular if the Act is eventually passed as expected.
While the previous incantation of the DOL fiduciary rule threatened to include fixed indexed annuities within its regulatory umbrella, it’s widely expected that they’ll be excluded from any new version of the fiduciary standard. Once the DOL fiduciary standard was taken off the table, fixed indexed annuity sales took off once again.
However, the impact of the DOL rule remains: a newly developed class of fee-based fixed indexed annuities has emerged to replace some of the commission-based products. These products can offer higher cap levels because the insurance company selling the product no longer pays the producer a commission on the product. However, clients should be aware that despite the attractive higher cap level, the earning potential of the fee-based fixed indexed annuity can end up the same because of the fee charged based on the account’s value.
Generally, clients will have to evaluate their risk tolerance with any fixed indexed annuity product and it’s up to the advisor to explain the pros and cons. Many expect that a commission-based product would end up providing greater overall returns in a bear market because there’s no set fee. With more robust market performance, the higher cap might be the better option.