Uncapped Fixed-Indexed Annuities

In recent years, the fastest-growing area of the annuity market has been the fixed-indexed annuity (FIA). Some say the primary reason is its irresistible sales pitch.

A number of major insurers have either entered or expanded their presence in the space in recent years. Long known for its position in the variable annuity business, Prudential entered the fixed-indexed annuity market earlier this year.

FIAs allow their holders to benefit from increases in a designated index, such as the S&P 500, without the risk they’d have by investing directly in that index through a mutual fund or ETF. All annuities, of course, are insurance contracts designed for retirement; they are not securities.

But FIAs credit annuitants when an index goes up and simultaneously offer downside protection via a floor, or bottom, when the index goes down. That is, clients are guaranteed a minimum interest rate, which could be as low as 0%, that protects both the principal and any credits accrued.

This protection comes at a cost. Most FIAs have a cap, so accounts don’t get the full benefit of index increases, only a percentage.

Lately, however, certain advisors have been recommending uncapped FIAs that remove the upper limit. But exactly when, why, how and for whom these contracts make sense gets a little more complicated.

For Those Nearing Retirement

Clients who are “approaching retirement have traditionally allocated more heavily to fixed-income products in an effort to de-risk their portfolios,” observes Roger Ibbotson, chairman and chief investment officer at Zebra Capital Management in Milford, Conn., and professor emeritus of finance at the Yale School of Management. “This approach is sound, but I am concerned that fixed-income returns will disappoint in the coming years because rates will rise, leaving retirees stressed for income.”

So Ibbotson recommends uncapped FIAs. He and his team recently completed a study that found, in part, that uncapped FIAs would have outperformed equivalent bonds on an annualized basis for the past 90 years. Ibbotson will address this subject and others on September 26 at Financial Advisor's Inside Retirement conference in Las Vegas.