by Sean Sparkman
And how do RILAs differ from a fixed- index annuities?
Both fixed-index annuities (FIAs) and registered index-linked annuities (RILAs) are products
that create additional income streams in retirement. However, the two types of products differ in their risk levels of risk exposure.
FIA contracts ensure the safety of your initial investment and provide a guaranteed interest rate for contributions made over a specific time.
Correlated to an underlying index, such as the S&P 500, FIAs can be structured to provide an income stream that you can’t outlive. A fixed index annuity could be an excellent addition to the retirement portfolios of people seeking predictable, reliable, risk-averse income and lower fees.
RILAs are a newer type of “hybrid annuity”, offering the benefits of both fixed and variable annuities. Registered index-linked annuities, like FIAs, are tax-deferred long-term savings
vehicles. But, unlike with a FIA, you might lose money in a RILA.
RILAs, also called “buffer” or “shield” annuities, are gaining popularity with people who are a few years out from retirement and willing to tolerate greater risk exposure in exchange for
potential upside growth. RILAs expose you to a degree of market risk with the potential to get more upside when the market is doing well.
A registered index-link annuity’s upside and downside limits are connected. Your RILA’s performance hinges on the underlying index change between the interest term’s start and the interest term’s end. Interest is then credited to the account based on the index growth (if any) at the end of the term.
If the index goes down by the term’s end, the annuity owner is protected against losses beyond the annuity’s “floor.”
For example, say you had a RILA whose index had declined by the end of the interest term. If your annuity’s floor was set at 15% and the index went down by 25%, you
would absorb the first 15%. The annuity company is on the hook for the remaining 10%.
Most RILAs have a lock-in feature that will let you lock in your annuity’s value on any business day before the end of the index performance term. Any interest earned is based on the start of the term and the lock-in date.
Issues with “buffer” annuities (RILAs)
You might be attracted to the concept of a RILA and like the idea of protecting against downside risk by limiting how much you’ll get on the upside. However, it is essential that you thoroughly understand RILAs and how they work before purchasing one.
Buffer annuities are even more complicated than FIAs or other annuities, and their underlying investments can be challenging to understand. Additionally, their downside protection is
somewhat limited, exposing your wealth more if the market plunges. To make things even more challenging, buffer annuities are not all the same. The performance of
a particular RILA might hinge on several elements, such as upside caps, buffers on downside risk exposure, and how much time each of these elements is in force. Each feature renews on a schedule determined by the annuity company and not by the owner. This aspect of buffers makes it hard to evaluate an individual RILA's performance and virtually impossible to compare it to other similar products.
Also, if you don’t fully comprehend how your particular annuity’s caps and buffers will impact your returns, you might be alarmed at your losses if the stock market plummets. You could also be upset to discover how much your annuity's cap limits your potential upside in a bull market.
Buffer annuities, like FIAs, offer retirees and pre-retirees the tantalizing prospect of having some protection against risk and the potential to gain on the upside.
Unlike FIAs, however, RILAs do not give you contractually guaranteed protection of your investment. Nor do they give you a guaranteed interest rate. Every buffer product on the market
is different, making it hard to perform meaningful research or comparison shop. If you are concerned about market losses but still want growth, there are other products you may
want to consider before choosing a RILA. Whatever you decide, it’s always a wise idea to work with a financial professional who can explain a product’s potential and perils and guide you to financial vehicles that best fit your risk tolerance and long-term financial goals.
👍Discover more about Sean Sparkman and Safe and Sound:
*This article is not intended to provide financial advice. It was written to educate, entertain and inform. Nothing in this article is promoting ANY financial product or service or may be construed as encouraging you to buy a product or service. Investors are urged to get advice from competent, experienced, licensed agents or advisors before making any money decisions.