With today's economic environment, many people are concerned with the market impact on their retirement savings and what that will mean to their overall retirement plans. Many people are choosing conservative insurance products with less risk but are still seeking some type of upside potential. People are looking for savings solutions that will provide opportunities for growth combined with protection from market downturns. Fixed indexed annuities (FIAs) can help address these challenges by offering more potential for growth than a traditional fixed asset and protection from market downturns.
FIAs are designed for people that have enough assets to cover living expenses and unexpected emergencies in retirement, such as medical expenses. An FIA offers some of the same benefits as fixed and variable annuities, including a death benefit for beneficiaries prior to receiving an income payment, tax-deferred interest and a choice of income distribution options.
The fixed indexed annuity offers the potential to earn interest tied to the performance of an index, such as the S&P 500. An FIA receives indexed interest during a rising market when the index is up, and the account value is guaranteed to never decrease in turbulent market conditions when the index is down. The value of the index may decrease but the interest rate is guaranteed to never be less than zero. Values will not be affected by a poor performing index before they can benefit from positive performance during subsequent indexed terms.
Benefits of FIAs
With market volatility comes the need for flexible retirement solutions. Many people are looking for retirement income options that will provide flexibility in asset allocations as well as distributions. FIAs offer these options when generating an income from the account value.
Distribution options include taking systematic withdrawals and annuitization, which allow for annual, semiannual, quarterly or monthly payments based on a person's particular needs. Annuitization provides a steady stream of income that cannot be outlived. Withdrawals may be subject to a market value adjustment. Also, people should be aware that with most FIA products, the income withdrawn before the end of an indexed term will not receive any indexed interest.
Fixed indexed annuities provide people the flexibility by offering a choice of fixed and indexed interest accounts with the ability to change account allocations at the end of the indexed term when the indexed interest is credited for the prior period. This means that people can move in and out of the fixed and indexed interest accounts at the end of each indexed term based on their individual needs.
Tax deferral on FIAs can also be a great benefit to people who choose this type of solution. Tax-deferred annuities have a greater potential for growth as the annuity earns interest as it is accumulating and would not have to be taxed until withdrawn. However, if income is withdrawn prior to the end of the surrender charge period, it may be subject to surrender charges and a market value adjustment. It may also be subject to income tax and, if withdrawn prior to age 59 1/2 , may even be subject to a federal penalty tax.
Optional FIA features
Many fixed indexed annuity solutions offer liquidity features including partial withdrawals and income benefits such as guaranteed lifetime withdrawal benefits (GLWB). A GLWB rider provides a guaranteed income regardless of index performance.
There is typically a fee for GLWB riders. Advisors offering these options to clients should understand whether that fee is based on the income value or the account value. A fee based on the income value becomes a larger percentage of the value once income starts. If there are fees, they may exceed interest credited, resulting in a loss of principal. Advisors recommending GLWB options should be sure to compare income factors between products.
Consider Rule 151A
The Securities and Exchange Commission (SEC) has issued Rule 151A on fixed indexed annuities for the purposes of regulation and producer licensing. This means that FIAs would be treated as a registered security, affecting how the annuities are distributed and sold by providers.
However, the U.S. Court of Appeals for the D.C. Circuit has ordered the SEC to reconsider the Rule because it did not properly consider the effect of the ruling on the industry. So, the regulatory future is uncertain for FIAs. Providers and advisors need to carefully understand Rule 151A and should continue to evaluate the effect that it may have on FIAs to avoid compliance issues if the Rule becomes effective.
Key points when recommending FIAs
There are many key factors that advisors need to consider when recommending fixed indexed annuities to their clients. Anything that really seems too good to be true, most likely is. It is important to evaluate the details of the contract and the provider before making a decision on what FIA is best for clients.
o Do a "background check" of the insurance provider. One of the first elements advisors should examine is the history of the provider. Advisors need to look at insurance providers and investigate the company's overall stability and financial strength. Company ratings are a good indicator of a company's financial strength. Another is the need to focus the crediting rate history of the carrier on similar types of products before making any type of decision on a carrier. Advisors should take caution if the first-year rate is high followed by below-market renewal rates.
o Consider surrender charges. Advisors need to check the surrender charge period and evaluate if it is a reasonable length. Clients should not have penalties to access money for an excessive length of time. Also, advisors need to be aware of the amount of the surrender charge and deem it reasonable for clients. People never really know if their life circumstances will change, so it is important to know what the fees will be if there is a need to access income before the end of the surrender charge period. There are several products in the market that will waive surrender charges in the event of terminal illness, nursing home confinement or annuitization.
o Think about limitations. Advisors need to be aware of the limitations or penalties, including bonuses that can be recaptured, if the client withdraws funds prior to a certain date. They should be knowledgeable of the product thresholds and consider if there is a threshold amount above which the client may receive an enhanced rate. Advisors need to know what happens if the client withdraws money taking the value below the set threshold.
Sound financial planning and retirement solutions that provide guarantees and downside protection ensure people do not outlive their income. Fixed indexed annuities can offer growth potential, wealth preservation through fixed interest earnings and protection from losses, income options and protection of a death benefit.
Kris Kattmann is vice president and associate actuary, retirement solutions, for Lincoln Financial Group. Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates.
