There is a famous quote from Albert Einstein that states: “In the middle of difficulty lies opportunity.” 2020 was certainly a year like no other for the financial services industry, but despite the unprecedented challenges, there was indeed opportunity. Financial professionals and their clients have been able to take a step back and revisit financial plans to ensure that all bases are covered, particularly in regards to managing risks related to retirement.

As a result, a relatively new product born out of the innovation of insurance companies, and a need to provide strong consumer value in an ongoing low interest rate environment, gained increased momentum in 2020. Registered index linked annuities (RILAs) came into greater focus as new carriers and products entered the market, and early pioneers continued to expand their offerings. According to the Secure Retirement Institute, total 2020 sales of RILAs were estimated to be at $24.1 billion (as of December 2020, final figures pending), up 38.5% over 2019 sales of $17.4 billion. 2019 sales were up 55% from 2018 and the forecast indicates continued growth in the area. (Source: Monthly Annuity Sales Report, Secure Retirement Institute, December 2020)

This exponential growth has been driven by clients who seek the long-term growth potential of equities and need to accumulate money for retirement, but also seek a level of protection from the uncertainty of the market. RILA returns are based on the performance of an underlying index but are not directly invested in the market, thus reducing the risk of direct exposure to equities, while maintaining that important upside potential.  On the annuity risk/return spectrum, they generally fit somewhere between a fixed index annuity (FIA) and a traditional variable annuity (VA).

Putting all of this aside, why should you consider a RILA for the right clients? While it is not necessarily an ideal fit for everyone, RILAs should be taken into consideration if the client’s risk/return expectations fall into the RILA “sweet spot”—needing more growth potential than what the persistently low interest rate environment can offer, but not willing to assume all of the risk associated with equity markets that have been volatile and recently near record highs. Taking a deeper dive into RILAs, here are some key factors to keep in mind.

The Good
• No time like the present — Given the current environment, we believe there is no better time than now to take a closer look at RILAs. Sitting on excess cash and/or being heavily invested in fixed income at unprecedented low interest rates can be a suboptimal strategy for building long-term wealth. And yet, protection and guaranteed income in retirement are top of mind for many clients. Integrating a RILA in an overall retirement strategy means your clients can participate in the opportunity for market growth, while knowing their loss potential can be reduced when the market experiences downturns, for RILAs that offer buffer or floor features.  Clients seeking the growth potential of the markets can be assured they are not being left out in the cold, but that they also have a level of protection if, and when, the next correction happens. For some, it can be the best of both worlds – growth potential and a level of protection.

• Tax advantages — Like all annuities, RILAs offer tax-deferred growth2, so as the annuity accumulates, there are no taxes until withdrawal. This offers an immediate advantage for clients who may have maxed out contributions to their retirement plan (e.g. 401k), and want to avoid the potential tax drag associated with investments in a taxable account. This tax deferral can help the money in the annuity accumulate faster.

• Flexibility — Client financial needs and goals can change over time. Many RILAs offer a variety of index strategies – also called crediting methods – and flexible options for receiving income through a rider that may be available for an additional fee. The client can also periodically change investment strategies to choose allocations based on their goals and risk tolerance.

• Lower costs — Many RILAs have no fees, or lower fees than traditional VAs.

The Other Side Of The Coin
• Timing is everything — While it may be a great time to consider a RILA in the current environment, the client’s age should be a factor when assessing the appropriateness of these strategies. Similar to traditional qualified plans, all annuities have tax implications for investors looking to withdraw funds prior to age 59 ½. (Withdrawals will reduce the contract value and the value of any protection benefits. Withdrawals taken within the contract withdrawal charge schedule will be subject to a withdrawal charge. All withdrawals are subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% federal additional tax.)

• Returns may be capped — The tradeoff of having floors and buffers to help mitigate losses, is there may also be an upside cap on some index options. Clients who can stomach volatility, expecting the potential that comes with full equity exposure, may be better suited to look at other vehicles that are directly invested in the market. Your clients could experience a loss during an index period if the index declines more than the level of downside protection. Your clients may also not be able to participate fully in a market recovery due to the capped upside potential in subsequent index periods.

• RILAs can have limited access — Clients looking for fast and easy access to funds might want to look at other options. Although there are free withdrawal provisions, RILAs are not designed to be liquid investments and should really only be considered for clients using the product as a long-term solution in their overall retirement plan.

No one has a crystal ball that can tell us what will happen next in 2021. However, as financial professionals, we have an ideal opportunity to help our clients plan for all possible scenarios, no matter what difficulties might be ahead. For some, RILAs might be a useful addition to their portfolio, providing the upside potential of the equity markets while offering the opportunity to incorporate risk management and thereby some reassurance in a world full of uncertainty.

Index variable annuities (also called RILAs) are subject to investment risk, including loss of principal, and contract values fluctuate daily. Investment returns and principal value will fluctuate with market conditions so that units, upon distribution, may be worth more or less than the original cost.

Purchasing an annuity within a retirement plan that provides tax deferral under sections of the Internal Revenue Code results in no additional tax benefit. An annuity should be used to fund a qualified plan based upon the annuity’s features other than tax deferral. All annuity features, risks, limitations, and costs should be considered prior to purchasing an annuity within a tax-qualified retirement plan.

Corey Walther is president of Allianz Life Financial Services LLC.