Will Retirement Investors Tolerate the Next Big Downturn? The Case for Fixed Indexed Annuities

No one can predict with any degree of certainty when the next market correction or bear market will occur, or how long it will last. What we do know is that, at eight years and counting, the current bull market has lasted twice as long as the average bull market. It’s safe to assume that investors, who are experienced in the ways of market cycles, have taken measures to prepare their portfolios for the likelihood of a market decline and renewed volatility. While that might ease their minds, it may not be enough to calm the nerves of those who are still reeling from the last market crash.

What Retirement Investors Really Want

Most retirees would rather not have to worry about their retirement assets losing value; but they also need to be able to generate returns that can at least keep pace with inflation. An ill-timed stock market decline can derail a retirement income plan and low-yielding vehicles can’t generate the income needed to support a comfortable lifestyle for 25 years or more. With their ability to shield their assets from stock market volatility while capturing a portion of stock market gains, indexed annuities may be the alternative retirees are looking for.

How Indexed Annuities Work

At its simplest, a fixed indexed annuity provides investors with the opportunity to generate higher yields based on stock market performance with downside protection. There are a lot of moving parts in a fixed indexed annuity, which is what enables it to achieve what no other investment can. Here’s a quick review of those parts:

Stock Market-Based Yields: The rate on a fixed indexed annuity is calculated as a percentage of the annual gain in the stock index, such as the S&P 500.

Capturing Market Gains: A portion of the stock index gain is credited to the account based on a participation rate. In a year when the stock index gains 15%, a contract with an 80% participation rate would credit 12% to the account.

Capping the Yield: Not all contracts would credit 12% to the investors’ accounts because they typically include a rate cap ranging from 4% to 15%. So, a 15% stock index gain might only translate to a 7% rate credit.

Eliminating the Downside: The portion of gains insurers retain in positive years is used to offset losses in negative years, which is how they still manage to credit a minimum rate even when the index declines.

Locking in Your Gains: Once a gain is credited to the account, it is locked in, which means the account will never decline in value.

What about Those Limited Returns?

One of the primary criticisms of fixed indexed annuities is their limits on returns. However, studies have shown that investors are willing to give up some upside for the possibility of limiting their downside. According to the Wheaton Financial Institution Center, “Indexed Annuity returns have been competitive with alternative portfolios of stocks and bonds and have limited downside risk associated with declining markets. And they also have achieved respectable returns in more robust equity markets.”

Financial planners are divided on the role or the effectiveness of fixed indexed annuities in portfolio planning. For some, it’s about the expenses typically associated with fixed annuities; but there are plenty of new products with low expenses. For others it is their illiquidity due to surrender charges; yet, investors do have free access to their funds up to 10% of their surrender value each year and 100% at the end of the surrender period. Contrast that with investors who feel locked in to their investments when stock prices suddenly decline, afraid to sell their investments at a loss. However, it is undeniable that the unique properties of fixed indexed annuities, even for a small portion of their retirement portfolio, can offer your clients something no other investment can – the peace-of-mind that comes with preserving their capital without sacrificing yield, which is priceless.

Index annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company, not an outside entity. Investors are cautioned to carefully review an index annuity for its features, costs, risks and how the variables are calculated.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.