Near to your retirement age and already worried about the risk of outliving your expenses? Then registered index-linked annuity (RILA) could be a solution for you. RILA is a good fit if you want to grow your retirement assets and can bear a certain degree of market risk. This annuity is related to the market index performance, providing a chance to gain positive index returns up to a cap rate while offering a level of protection i.e. buffer, if the index return is negative. Some registered index-linked annuities come with administrative and or contract fees. Registered index-linked annuities are suitable for the person if:
- They are soon approaching retirement.
- Seek equity-like returns if there is positive index performance and a degree of protection in case of negative index performance.
- Wants tax-deferred growth potential.
What is Registered Index-Linked Annuity?
The Registered Index-Linked Annuity is a hybrid annuity that offers the advantages of both a fixed index and a variable annuity. RILA is an ideal choice for investors who want to control their downside exposure but are willing to bear more downside risk in anticipation of high upside growth potential.
This investment-based annuity is often called an index-linked variable annuity. The index-linked annuity is different from the fixed index annuity. There is a chance to lose money in an index-linked annuity; however, fixed index annuity doesn’t have this disadvantage.
Similar to the fixed indexed annuities, RILAs offer the opportunity for growth on the stock market index’s performance. Other similarities are:
- tax-deferred growth potential
- Yearly free withdrawal amounts
- Option to convert the annuity into income streams in retirement.
Moreover, fixed-indexed annuities and TILAs are not stock market investments and do not directly involve equity or stock investments.
With a fixed indexed annuity, the index works positively: the annuity earns interest credits, capped or limited by the participation rate.
Should the index perform negatively, an annuity holder will only lose money to the ‘buffer’ or ‘floor’.
What is an Index?
A group of securities whose performance (or change in value) serves to measure the performance of a particular market segment or the entire bond or stock market is called an index. An index just measures the market performance. It is not possible to invest in the index.
Key Features of RILA
Some of the noteworthy features of RILA include:
- Growth potential is linked to an index’s performance, controlled by a cap, or based on a trigger rate or participation rate.
- Account options were developed to offer some protection against market losses.
- A person can withdraw at any time, so they always have access to the money.
- A person can enhance the growth potential by choosing the indexed accounts carrying an annual charge.
- Growth is tax-deferred (it’s not taxed until you take it out), so it can compound over time.
- A person can convert the money into a stable income stream on retirement.
Surrender Charge Period
Most of the annuities let people withdraw a certain proportion of their contract free of any fees from the start. However, since annuities are long-term products, if a person withdraws more than the free withdrawal part early on, they will incur a penalty termed as a surrender charge. The surrender charge period is the time frame one needs to wait for before withdrawing more funds without incurring these surrender charges.
How does RILA Works?
The pros and cons of RILAs are linked, so a higher degree of protection from downside risk implies a lower cap on the upside potential and vice versa. If the index performance is positive during the term, the annuity might earn interest credits based on the cap or participation rate. Index declines can lead to negative interest credits, with a degree of protection from any potential loss.
Downside protection: The market loss exposure limit of the RILA is based on two options i.e. buffer and floor.
Buffer: Fraction of downside protection, usually from 10 to 30 percent. For instance, if an index falls by 15 percent and a person selects a 10 percent buffer, they would experience a loss of 5 percent.
Floor: A person is exposed to a percentage loss below the “floor” amount. If a product has a 10% “floor” but the market falls by 15%, the person would lose only 10%. The floor limits the downside.
What is a Lock-in Feature?
The lock-in feature enables the annuity owner to lock in a value on any business day before the end of the index-performance term. Interest gained and applied to the index-linked annuity is based on the start of the term and the lock-in date.
Like variable and index annuities, the index-linked annuity gives annual withdrawals with no penalty. The death benefit is the lump sum to beneficiaries or spousal continuance for surviving spouses. Annuitization is also an option if the annuity owner needs a steady income stream.
The Premium’s Waivers are also available for eldercare purposes (terminal illness, long-term care, nursing home, etc.)
Meeting the Accumulation Need
Registered index-linked annuities help people accumulate money for retirement or other long-term needs. If you seek an option that gives lifetime income, another annuity solution could be a better fit. RILA may be an option if you are close to retirement. It can provide tailored protection and growth plans to help you meet your retirement goals. Its range of investments may be beneficial for those planning to retire in the next 5-7 years.
It is essential to be aware of your “comfort zone” when it comes to risk. You should ask yourself the question, “how much risk are you willing to bear to develop your retirement nest egg?”. The right mix of risk and return potential increases confidence in their retirement plan and helps them stay in their financial comfort zone.
Some of the downsides of Registered Index-Linked Variable Annuity (RILA) are as follows:
- Complexity: All variable annuities are complex financial products. The Indexed-linked variable annuities are no exception. It costs a person to research and consult with a professional such as an independent insurance agent.
- Less Liquidity: Indexed-Linked variable annuities are retirement products. They are long-term investments. If a person needs access to money, they have no good choice. Indexed-linked variable annuities carry surrender charges, usually for 6 to 10 years. There is a penalty tax for withdrawals before the age of 59 ½.
- Limited Choices: Index-linked variable annuities don’t offer the same big menu of investment options that other variable annuities offer.
What You Can Accomplish Through RILA?
An index-linked annuity indeed isn’t a one-size-fits-all solution. Portfolio losses in this period can be hard to make up for and might affect the lifestyle choices for years to come. However, for investors with a series of returns risks, assigning a part of the portfolio to the RILA might protect their metaphorical mugs from the overwhelming haymaker in this “fragile decade.”
This is a sort of behavioral protection: Transferring certain risks to the insurance company for some surety of a defined outcome. The promise of certain returns and the protection against losses can lead to the confidence to remain in a market and on track to hit the investment objectives instead of waiting for the next hard hit.
If you have an investor-like mind, are about to retire, and are loss averse, behavioral tools can help you to be decisive in such times. However, to invest in an annuity, you must keep your guard up and consult your financial adviser regarding your options.
When you’re about to turn your annuity into your retirement income, you can choose from a range of payout options, including the income stream that will be there for the rest of your life. A registered index-linked annuity might be the right choice to maximize your money based on the market performance if you’re eager to take on some risk for the competitive earning potential. If you want complete protection against the market loss, you might want to opt for a fixed or fixed-indexed annuity.
Investing in a stock market might be lucrative, but with the least protection against the loss, a market downturn may wipe out your years of savings. Like bonds, fixed-income investments can offer some protection against loss but can offer less return, risking your retirement plans. A registered index-linked annuity brings a balance to your portfolio by enabling participation in market growth while decreasing the exposure to your market loss, helping you achieve your long-term retirement goals.