Fit To Be Fixed…
January 18, 2018 by Wayne Hechanova
We see the headlines and speculation every day. Can the bull market continue or are we about to experience a market collapse? How much longer can interest rates remain low? With all of this uncertainty, clients, particularly those stung by the 2008 market downturn, are at a financial planning crossroads.
Should your clients continue to ride out the amazing returns they have been experiencing and remain heavily invested in equities, or begin to pull back and have some level of protection in case the market begins to fall? In the past, clients could simply diversify a portfolio with bonds and CDs. However, with interest rates remaining low, the relative security blanket that comes with those options also comes with loss of potential upside.
Thus, clients are dealing with a Catch-22. It is in this environment that fixed index annuities (FIAs) have and continue to experience a surge in popularity given their ability to offer guaranteed protection from market downturns as well as growth potential.
There are many FIAs on the market, so how do you help clients identify the one that works best for them? First, work with your clients to consider common issues that FIAs address to determine if they could be a solution. Then, take it a step further by answering important questions to help narrow down the options.
Common FIA features
FIAs have no market index risk
They protect the principal and credited interest from market downturns by not being directly invested in shares of any stock or index fund, so if the index performance is negative, no interest is credited – while the value won’t increase, it won’t decrease either because of negative index performance. However, the deduction of any fees associated with the annuity may decrease the contract values.
There is opportunity for growth
Clients can choose to receive interest based upon changes in one or more external market index. They can also earn interest through a fixed rate. Additionally, under the current federal income tax law, clients don’t have to pay ordinary income taxes on any taxable portion until they begin receiving money from their contract. At that time, withdrawals are taxed as ordinary income (of course if they take it before age 59 ½, a 10% federal additional tax may apply.)
FIAs offer income for life
Imagine the level of stability your clients can have if they know that part of their retirement income will always be there for them. Many clients allow their contracts the opportunity to earn interest over its accumulation period, and then choose from several annuitization options when they want to begin receiving payments.
Some FIAs also have income riders or benefits (sometimes for an additional cost) that offer lifetime payments and may give the opportunity for income to increase which helps address inflation risk. Additionally, once income payments begin, any remaining contract value can often be passed on to their beneficiaries when they pass away.
Now, dig deeper and ask these questions to help wade through all the FIA choices available.
Are there a variety of allocation options?
An allocation option is a combination of an external market index, and a crediting method. Having a wide array of options is important because allocations can work differently in a variety of market conditions. There is no single allocation option that would provide the most interest in all market scenarios.
Thus, by diversifying the index exposure and crediting methods within the FIA, clients can spread out the interest potential and volatility of the contract over different economic cycles. Additionally, principle and credited interest would be locked in and protected during periods of index decline. Keep in mind that diversification alone does not ensure interest will be credited.
Are there fees that can impact performance?
Many FIAs have fees that could be deducted from the contract value and many include a surrender charge for a period of years. So, fees and charges should absolutely be understood by the client as they could impact the bottom line of growth.
How and when was the index constructed?
When looking at indexes, look at the past performance of each index and check to see if it was overfitted. The more complicated the index, the more tailored it may be to address past market behavior versus being based on what would happen in the real world. To help avoid this complicated issue of index design overfitting, compare the backcasting results to a real-world experience, understand who the index administrator is, and find how the index was constructed (these should be published).
How long is the crediting term?
Many clients may want to be flexible and be able to pivot as the environment changes. Check on the flexibility of the allocations to see how often they can be adjusted.
What is the strength and stability of the product issuer?
FIAs are a contract between the client and the issuing company (they are not FDIC insured). So, strength and stability of the issuing company are imperative since the guarantees of the contract are backed by that company. Before making a decision, consider the issuing company’s financial ratings, their investing strategy, and their historical financial strength.
Is there increasing income potential?
Another key reason why people use FIAs as part of a retirement portfolio is the fact that some give the opportunity for income to increase. For clients who are concerned about inflation risk, having the chance to receive increasing income throughout retirement could be extremely valuable.
Keep in mind that when looking at increasing income options, the client will need to know how these options work with the allocations in the product, and consider if it comes at an additional cost.
Clients need all the certainty they can get when it comes to their retirement portfolio. For a portion of their assets, FIAs help protect against market risk, provide opportunities for growth, and can provide lifetime income. Financial professionals can do a great service by educating clients about the common-known benefits of FIAs as well as asking the deeper questions to find out if an FIA could work for their client’s situation. ◊
This content is general information for education purposes, not intended to constitute fiduciary advice. Please consult your financial professional for a specific recommendation to purchase this product.
● Not FDIC insured ● May lose value ● No bank or credit union guarantee ● Not a deposit ● Not insured by any federal government agency or NCUA/NCUSIF
Guarantees are backed by the financial strength and claims-paying ability of the issuing company
Mr. Hechanova is vice president of Product Insights for Allianz Life Insurance Company of North America. Visit www.allianzlife.com