A steady retirement paycheck to withstand any market conditions
Fewer than 4 in 10 of American adults who aren’t yet retired feel that their retirement savings are on track, according to The Federal Reserve Board. And nearly 6 in 10 with self-directed retirement savings expressed low levels of comfort in making investment decisions with their accounts. Although financial preparedness for retirement seemed to increase the closer they were to retiring, those near retirement age still felt concerned that what they had saved may not be enough.
Balancing growth and protection
When consumers get to the late stages of retirement planning, they typically shift from seeking growth to wanting to balance growth and principal protection. Changes in the broader economy can also prompt a change of mindset. In a slowing economy, consumers pivot to a more conservative stance and start thinking about securing retirement income. When one or both of these dynamics are in play, financial professionals have an opportunity to explain the features and benefits of fixed indexed annuities (FIAs) and similar products.
Like traditional fixed annuities, FIAs protect against loss of principal due to market downturns and offer the option of a fixed interest rate. Some products also have features that allow consumers to turn on a guaranteed income stream in retirement. But the unique structure of the FIA also provides an opportunity for higher returns to grow the nest egg. Each year, the consumer is credited with a return that is benchmarked to a stock market index. "They can be indexed not just to the S&P 500®, but other indices, providing appeal and customer choice," shares Michael Downing, executive vice president and chief actuary at Athene.
Weathering market volatility
Fixed indexed annuities may be attractive for consumers who are accustomed to stock investing and may still maintain an accumulation mindset. They provide a safer strategy for those who are concerned about coming market volatility. "FIAs are long-term financial products with a five, seven or 10-year period during which access to the money may involve paying withdrawal charges, which consumers generally avoid. That allows the insurance company to invest that money and provide more value to customers. It takes the customer out of a lot of volatility. And what they get offers principal protection from market loss with more accumulation potential than other safe strategies," states Downing.
The characteristic feature of FIAs is the zero-return floor. "The biggest feature is that you are guaranteed not to go through the floor. If 2008 comes again and the markets are down 40%, you are protected," says Downing.
Consider a consumer who pays a $100,000 premium for a fixed indexed annuity. In a year in which the S&P 500® index dropped 40%, she would retain her full $100,000. In a rising market, she would receive a portion of the index return, called her participation rate. If her contract stipulates a participation rate of 50%, in a year that the index gained 10%, she would be credited with 5%, for an account balance of $105,000.
Securing a steady retirement paycheck
Consumers can customize FIAs by choosing features that match their particular needs — like a guaranteed fixed interest rate, lifetime income or an enhanced death benefit — along with principal protection from market loss provided by the zero percent floor.
For customers who are largely on track with retirement savings, the financial professional can suggest replacing equities with FIAs as they get older. "Here's a way we can replace a portion of your portfolio that has equity exposure with a fixed indexed annuity, to increase your ability to weather a market downturn," says Downing.
Bridging the gap with wider boundaries
For customers who want greater accumulation potential with greater risk, or for younger clients with slightly higher risk tolerance, a different type of annuity might be suitable. A newer product, the registered index-linked annuity (RILA), offers a similar proposition to the FIA, but with more zing. Unlike the FIA, the RILA has a return floor that is lower than zero.
"Instead of a floor of zero, I may have a floor of -10%. The first 10% of any market losses, you'd see reflected in your account value," says Downing. In a year that the index returned -10%, the investor from the above example would see an account balance of $90,000. If the market returned -40%, her balance would still be $90,000 because her losses are limited.
At the same time, RILAs can be structured with much higher participation rates than FIAs. "There is more upside opportunity in RILAs. That makes them a good way to bridge the gap between fixed income and equities," says Downing.
"On the upside, I may have a 15% cap, instead of 5%. If the market went up 20%, I'd have $115,000 instead of $105,000. You still have boundaries, but the boundaries are wider," he continues.
Withstanding any market conditions
Downing adds that FIAs and RILAs may come to be seen as a useful solution for the broad swath of consumers who currently use target date funds. While those funds use algorithms to automatically reduce risk as the consumer gets older, they offer fewer guarantees in retirement. "The biggest downside [of target date funds] is that they don't consider how you are going to pull money out. You are exposed to equity market downturns and you have interest rate risk because of the fixed-income," says Downing.
FIAs and RILAs are long-term insurance contracts that provide growth based in part on the performance of a market index while providing a level of protection from market risk. Older consumers want to be insulated from extreme stock market troughs, because they can't afford the time it can potentially take to recover from an extreme crash. FIAs and RILAs provide greater accumulation potential than fixed products along with secure guarantees that can help consumers safely weather extended market downturns.
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