Close Close
ThinkAdvisor
Robert Bloink and William H. Byrnes

Life Health > Annuities > Variable Annuities

Can a Registered Index-Linked Annuity Protect Your Clients in a Down Market?

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • RILAs are registered with the SEC because they do carry some potential for investment loss.
  • Most RILAs offer the investor only a degree of downside protection.
  • RILAs may appeal to clients concerned with losing the opportunity to participate in market gains.

With interest rates rising and the stock market showing no signs of a rebound, many clients may be considering whether now might be the right time to lock some of their funds into an annuity product.

Registered index-linked annuities (also known as “RILAs,” index-linked annuities or buffer annuities) have surged in popularity in recent years. For the right client, a RILA can allow the client to participate in some market gains while also limiting the risk of loss in today’s shaky market.

While these products may seem too good to be true in light of recent losses, it’s important for advisors to evaluate these products carefully in light of the client’s future needs to prevent unhappy clients — and even potential liability — down the road.

RILAs: The Basics

Registered index-linked annuities are tax-preferred long-term investment products that satisfy the IRS’ requirements for tax deferral with their annuitization feature. Like other variable annuities, RILAs are registered with the SEC because they do carry some potential for investment loss.

RILAs credit gains and losses to the individual investor’s account based on a formula that doesn’t directly mirror the underlying fund’s performance. That formula can be based on single-year terms or multi-year terms.

These annuities do not completely protect (or claim to protect) against the risk of investment losses. Most products offer only a degree of downside protection (they provide a “buffer” against market losses). For example, when a RILA offers a 10% buffer against losses, the insurance company that sold the product will absorb the first 10% of losses. The investor experiences the remainder of the loss.

On the other hand, it’s also possible to select a “floor” option for determining downside risk. In these cases, the investor experiences loss up to the “floor” percentage. Any additional losses are absorbed by the company offering the annuity product. So, in a case involving a 10% floor and 15% in losses, the client would experience the first 10% of loss, yet would be protected against the remaining 5% in losses.

Because of the potential for some investment loss, however, the RILA also typically offers higher participation rates (or “caps” on the investment gains the client can realize within the annuity product). That itself may make the product more appealing to clients concerned with losing the opportunity to participate in market gains if and when the stock market eventually rebounds.

Is a RILA Right for My Client?

Registered index-linked annuities tend to be more complex than typical annuity products. While the product itself is still tied to an underlying fund (such as the S&P 500), many different formulas can be used to calculate the actual client’s gains and losses in the contract (because the annuity performance doesn’t directly mirror the fund’s performance).

On the other hand, the use of custom indexes in RILAs is also on the rise. Those indexes can address the issue of lower interest rates while also allowing the client to choose volatility-controlled funds so that the client had added protection in a bear market.

While RILAs have recently added some guaranteed lifetime withdrawal benefits (GLWBs), those GLWBs are more unpredictable than GLWBs that are attached to typical fixed indexed annuities. The financial benefits under the rider itself will depend heavily on how the underlying RILA index performs.

In the end, RILAs may be most appropriate for clients who are interested in accumulation, rather than providing guaranteed lifetime income in retirement. RILAs are riskier than fixed annuities that provide stable and guaranteed retirement income. So, RILAs may be most appropriate for clients who are looking for a way to supplement their retirement strategy with a tax-deferred growth option.

Clients who are further from retirement may benefit from a typical variable annuity, which is somewhat more risky than a RILA. For example, if the client is 15 to 20 years from retirement, the typical variable annuity will allow the client to participate in the underlying market more actively, assuming the client has more time to recover from bear market conditions.

Conclusion

RILAs are a type of annuity product that is still evolving. Current legislation would change the complex registration requirements that currently make it more difficult for carriers to offer these products. Still, for clients who are approaching retirement age, the RILA option can offer a solution that may be especially valuable in a down market.