Meet the Newest Member of the Protected Income Family: The RILA (well, not really new)
By: David Blanchett, Senior Education Fellow, Alliance for Lifetime Income
There’s a new annuity in town and it’s attracting a lot of attention. Actually, registered index-linked annuities (known more simply as “RILAs,” or occasionally as structured or buffered annuities) aren’t really new, but they are experiencing a renaissance as the pandemic alters what American’s look for as they reconsider how best to both grow and protect their nest egg and income in retirement. In fact, sales of RILAs have nearly doubled over the past year.
If you’re considering whether a RILA might be a good fit for your retirement planning needs, it’s important first to understand the basics of these products, how they work, and their benefits.
Investors often want the impossible: infinite upside potential with no downside. While this isn’t a realistic goal, it is possible to implement a strategy that has some upside potential while also limiting the downside risk.
RILAs are similar to fixed index annuities (FIAs), but they have been adjusted to achieve greater potential growth. If you were to “look under the hood” of a RILA you would find a selection of financial options selected to deliver a specific amount of investment growth and protection. They create more potential upside for the investment—compared to traditional FIAs—while creating some possibility of investment loss. RILAs enable you to access this type of investment strategy and benefit by putting these options together in one simple and convenient package.
How RILAs work: The basics
With FIAs, RILAs, and other similar products, the upside potential is typically described in terms of the participation rate and the cap.
- Participation Rate: The percentage return of the underlying benchmark, such as the S&P 500, you can receive (or can be credited with) over the period. For example, if the participation rate is 50% and the benchmark rises 30%, the investor would be credited with half the return (which would be 15%).
- Cap: The maximum potential return you can earn. Meaning, if the cap were 10%, the investor could not earn over 10% for the given period, even if the performance of the underlier was higher.
When it comes to potential investment losses, how much your investment in a RILA could decline, depends on the structure of the individual product, but there are two primary flavors: floors and buffers.
- Floors: Limit the maximum potential loss to some predetermined level. For example, if the floor is 10%, you can’t lose more than 10% even if the underlier return is significantly worse.
- Buffers: “absorb” the first amount of losses but subject the investor to the remaining possible downside. For example, if the buffer is 10%, the first 10% of losses is covered, but that’s it.
One simplified way to think about the difference between is that products with floors are more “bond-like” because the maximum possible loss is known beforehand. This is only a rule of thumb, though, and investors should always understand the individual characteristics of the product their considering.
RILAs’ appeal in low interest-rate environments
As interest rates have fallen and stayed down over the past year, traditional FIAs have responded by reducing their caps, i.e., the maximum gain the investor can receive. If an investor is looking for a protected strategy but wants more upside, FIAs may have become relatively less attractive. RILAs on the other hand likely represent an appealing alternative, as they are designed to increase the cap—relatively speaking—by accepting some downside risk.
The bottom-line: Like other annuities, and unlike other retirement investment products, RILA’s are a protected income product which can play an important role in a comprehensive retirement portfolio. The difference is that RILA’s provide more upside gain for the investor while assuming a little more downside risk.
More options for better tailored strategies
Over the past few years, increasing demand for protection solutions has created significant innovation in annuities. A variety of different annuity types and choices are available today to serve different needs or solve different retirement planning problems. There are still only four fundamental types of annuities in the marketplace – Variable, Fixed, Fixed Indexed and Registered Indexed-Linked annuities. And, some of these can be immediate or deferred, again depending on your need or problem you’re solving. It’s always important to understand how the various products work and how they may fit into any individual investor’s financial plan.
RILAs offer an interesting option compared to more traditional annuities, given the higher possible upside return but with varying types of downside risks. The differences in the potential return between different RILAs means that investors have a wider selection of potential choices enabling them to make investments more customized to their individual financial plan or strategy. One reason why RILAs have become potentially more attractive to a wider range of investors and so popular over the past couple of years.
While the potential benefits of RILAs depend on each individual’s situation, they create new possibilities for tailored investment strategies for investors looking for a specific type or amount of protection while maintaining the potential for investment growth.