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.
