With interest rates on the rise and the stock market showing no indications of a recovery, many clients may be pondering whether or not it is the ideal moment to invest a portion of their savings in an annuity product.
In recent years, the popularity of registered index-linked annuities (also known as “RILAs,” index-linked annuities, and buffer annuities) has soared.
For the proper client, a RILA can allow participation in certain market gains while minimising the danger of loss in today’s volatile market.
In light of recent losses, many products may appear too good to be true. However, advisors must analyze these products carefully in light of the client’s future needs to avoid dissatisfied clients and possibly potential liability in the future.
The Basics of RILAs
Registered index-linked annuities are tax-favoured long-term investments that meet IRS requirements for tax deferral due to their annuitization feature. Similar to other variable annuities, RILAs must be registered with the SEC due to the risk of investment loss.
RILAs credit gains and losses to an individual investor’s account based on a formula that does not directly reflect the underlying fund’s performance. This formula may be based on either one-year or multi-year terms.
These annuities do not fully protect (or claim to protect) against investment loss risk. Most products offer only a limited degree of downside protection (they provide a “buffer” against market losses).
For instance, if a RILA provides a 10 per cent buffer against losses, the insurance company that sold the product will absorb the first 10 per cent of losses. The remainder of the loss is borne by the investor.
On the other hand, a “floor” option is also available for determining downside risk. In such situations, the investor suffers losses up to the “floor” percentage.
Any additional losses are absorbed by the provider of the annuity product. In a case with a 10 per cent floor and 15 per cent in losses, the client would experience the first 10 per cent of loss but be protected against the remaining 5 per cent in losses.
Due to the possibility of investment loss, RILAs typically offer higher participation rates (or “caps” on investment gains the client can realize within the annuity product).
This may increase the product’s appeal among clients concerned about missing out on market gains when the stock market eventually recovers.
Does My Client Require a RILA?
Registered index-linked annuities are typically more complex than conventional annuity products.
While the product is still tied to an underlying fund (such as the S&P 500), many different formulas can be used to calculate the client’s actual gains and losses in the contract (since the annuity performance does not directly reflect the fund performance).
In contrast, the use of custom indexes in RILAs is on the rise. These indexes can address the issue of low-interest rates while also allowing the client to select volatility-controlled funds, thereby providing the client with additional bear market protection.
RILAs have recently added some guaranteed lifetime withdrawal benefits (GLWBs), but these GLWBs are less predictable than the GLWBs that are typically attached to fixed-indexed annuities.
The rider’s financial benefits are highly dependent on the underlying RILA index’s performance.
In the end, RILAs may be most suitable for clients who are more concerned with accumulation than with receiving a guaranteed lifetime income in retirement.
RILAs are riskier than fixed annuities, which provide stable and assured retirement income. Consequently, RILAs may be most suitable for clients seeking to supplement their retirement strategy with a tax-deferred growth option.
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Clients who are further away from retirement may benefit from a variable annuity, which is somewhat riskier than a RILA.
For instance, if the client is 15 to 20 years away from retirement, the typical variable annuity will allow the client to participate more actively in the underlying market, assuming the client has more time to recover from bear market conditions.
Conclusion
RILAs constitute an evolving type of annuity product. Current legislation would alter the complicated registration requirements that make it difficult for carriers to provide these products.
Nonetheless, for clients who are approaching retirement age, the RILA option can provide a solution that may be particularly advantageous in a bear market.
