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How do indexed annuities work?

Attractive interest rates, product innovation and competition in the market ignited tremendous sales growth in 2021 for two types of indexed annuities — fixed indexed annuities (FIAs) and registered index-linked annuities (RILAs). According to the Secure Retirement Institute, $39 billion in RILA sales, a 62 percent increase from 2020, and $63.7 billion in FIA sales, a 15 percent increase from 2020, marked the largest annual growth for these products in the last three years.

As more people become interested, it’s important to understand what makes these products unique so you can recommend the retirement savings solutions that will help your clients retire to the dreams they’ve nurtured for years.

Let’s start with the basics.

Indexed annuities are insurance products that combine index-linked growth potential with a level of protection from market risk.

Money in an indexed annuity is not directly exposed to the risks of the stock market or individual stocks. Instead, interest credits are based in part on the performance of a reference index, like the S&P 500®. Any positive change in the index over a specified term period results in interest credits that are applied to the annuity’s accumulated value.

Here are four important questions to answer when considering a FIA or RILA for your client.

  1. What kind of risk protection can I offer my client?
    One of the main differences between FIAs and RILAs lies in the level of protection from market risk. FIAs provide 100 percent protection from loss due to market downturns. While it’s possible to earn zero percent interest, you’ll never earn less than zero.

    RILAs provide protection from a portion of market loss, usually in the form of a buffer or floor. A 10 percent buffer shields your client from the first 10 percent of any index decline. A 10 percent floor provides protection from any decline greater than 10 percent. In both cases, the client may receive negative interest credits and risks a loss of principal.

    In exchange for this risk, RILAs typically offer greater growth potential in the form of higher caps or participation rates.
     
  2. What underlying indices does the annuity track?
    Indexed interest crediting strategies may track benchmark indices like the S&P 500® or custom indices designed to manage volatility risk while pursuing goals such as noncorrelation to major equity indices.
     
  3. How does the annuity measure index returns?
    Indexed crediting strategies typically measure the change in index value between the start and the end of a term period. This is called a point-to-point strategy. In addition, the tracked return may include or exclude dividends (total return) or returns in excess of the risk-free rate (excess returns).
     
  4. What is the annuity’s crediting strategy?
    Indexed interest credits typically are based on a formula such as a cap (an upper limit on return), participation rate (the percentage of an index’s return credited to the annuity) or a percentage-based fee such as a spread.

    For example, if the benchmark index returns 8 percent, an indexed annuity with a 4 percent cap will receive an interest credit of 4 percent; an indexed annuity with a 90 percent participation rate will receive an interest credit of 7.2 percent; and an indexed annuity with a 2 percent spread will receive 6 percent.

Whether it’s waking up to a new view on long-awaited travels or listening to grandkids giggle on park swings, retirement dreams are as unique as your clients. Modern annuities are designed to help them achieve the goals that are most important. Incorporating indexed annuities into a retirement strategy could be an important part of a solution that helps your clients retire their way.

This information is brought to you by Athene — where innovative annuity solutions and unique interest crediting strategies are powered by unconventional thinking.