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An investor checks his RILA annuity

A registered index-linked annuity (RILA) is a specific type of annuity that’s designed to provide income while managing risk. A RILA tracks the movement of a stock market index in order to produce positive returns, while simultaneously giving the annuitant the ability to establish a maximum risk threshold. This version of an annuity could be an option for investors who are interested in indexed annuities, but are hoping for better returns than a fixed-rate annuity might produce. A financial advisor can help you decide if a RILA or another annuity type is right for you.

What Is a RILA?

A registered index-linked annuity is an annuity that’s designed to limit exposure to downside risk, while generating positive returns. Returns generated by a RILA are based on the performance of an underlying stock market index or indexes. The annuity does not invest directly in any stocks or equity securities.

RILAs are deferred annuities, in that the annuity owner begins receiving payments at a later date rather than right away. They’re sometimes referred to as buffered annuities or hybrid annuities because of the way they’re structured and what they’re designed to do.

In general, this type of annuity could be suitable for someone who:

  • Is retired or getting close to retirement
  • Prefers an annuity that offers returns comparable to stock market performance with built-in protection against potential downturns
  • Is interested in tax-deferred growth potential

RILA annuities can offer some advantages over fixed-rate annuities and indexed annuities, in terms of the returns they may produce and the level of insulation against risk they provide.

How a Registered Index-Linked Annuity Works

African-American man checks his RILA annuity

A RILA annuity works by allowing the purchaser to build protection against losses into the contract itself. When you purchase this type of annuity, you can decide how much risk you’re comfortable with and how much downside exposure you’d like to have. You can then choose from different indexing options based on how much growth potential they offer.

In other words, losses are limited if the market goes down. Conversely, gains are limited as well if the stock market goes up. There’s a balance, in that the same limits apply so you can’t have bigger gains than losses or vice versa. The limits imposed are determined by your own choices. Specifically, you can set a floor or buffer when structuring a RILA annuity.

If you choose the floor option, you’re establishing a maximum loss you’re willing to take as the result of a market downturn. Any losses in excess of this limit would be shouldered by the company you purchased the RILA from. With the buffer option, you’re choosing a percentage of loss that you don’t want to accept. Your losses would be limited to the amount by which market index losses exceed your chosen buffer.

In either case, your gain or upside is limited to the same extent or degree. Whether it makes sense to choose a floor or buffer depends on how much risk you’re comfortable with. With a floor, you’re drawing a line in the sand on risk, even if it means capping potential returns. A buffer offers more leeway in that it can allow for higher returns. But a buffer can also leave room for more risk in your annuity structure.

Advantages of Registered Index-Linked Annuities

Opting for a RILA annuity over another type of annuity could yield some benefits in the form of income, potential growth and risk management. You can defer paying any taxes on the growth of the annuity until you start receiving payments from it. The income itself could be helpful in retirement if you’d like to supplement Social Security benefits, 401(k) or IRA distributions or withdrawals from a taxable brokerage account.

Aside from that, RILAs offer some benefits you don’t necessarily get with fixed-rate annuities or other indexed annuities. This type of annuity gives you the best of both worlds, in that you can capitalize on market growth without being invested in stocks directly and you can also limit room for losses by establishing a floor or buffer. That could be appealing if you’re looking for an annuity that offers an optimal balance between risk and rewards.

You also have some control in terms of when and how you receive payments from the annuity. With a RILA, you can opt to receive payouts for a fixed period of time or for life. If you’re married, you can set up the payout structure so that your spouse continues to receive payments from the annuity after you pass away. And again, no taxes or fees apply until you begin making withdrawals.

How to Choose a RILA Annuity for You

A woman checks her RILA annuity

If you’re considering a registered index-linked annuity, it’s important to do some research beforehand. You may want to talk with your financial advisor first, as they can help you weigh the pros and potential cons of a RILA and help you to better understand what you need in terms of your risk tolerance and your preferred payout options. When choosing a RILA, there are three important things to focus on:

  • Time horizon
  • Floor or buffer
  • Index options

First, consider how long you want the annuity to be able to grow and when you think you’ll begin receiving payments from it. Also, consider the surrender period and what fees may apply if you rethink your purchase and decide to cancel your annuity.

Next, think about where your ideal comfort zone lies and where that might require you to set your floor or buffer. Again, the buffer could result in larger returns from a RILA but it can also carry higher risk. If you’re interested in a more conservative option, you may be better off choosing a floor of 10% or 15% instead.

You’ll also want to look at your options for indexing. RILAs can be tied to a variety of stock indexes, including the S&P 500 Index and the Russell 2000 Index. Understanding what each index tracks can give you an idea how it tends to perform.

Comparing annuity company ratings is also an important part of the process. Annuity companies that have higher credit ratings are less likely to default on annuity agreements. That means you have a better chance of getting paid once the time comes to start withdrawing from the annuity.

Finally, consider the fine print details such as which states the annuity is offered in, what fees you might pay and the minimum amount required to purchase it. The minimum investment can range from $25,000 to $100,000 or more so it’s important to understand what you’ll be expected to pay upfront or on an ongoing basis to maintain the annuity.

Bottom Line

A RILA annuity could be right for you if you’re looking for a reliable source of income for retirement. The way these annuities are structured can offer some unique benefits if you’re looking for both upside and downside protection while enjoying tax-deferred growth. However, an annuity should only be a supplement to your retirement plan. They don’t supersede IRAs, 401(k)s or other types of retirement savings vehicles.

Retirement Planning Tips

  • Consider talking to a financial advisor about whether a registered index-linked annuity might be right for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Annuities can help to make your retirement more secure but there are other elements you might consider adding to your financial plan as well. A variable universal life insurance policy, for example, could be a good option if you’re interested in securing a death benefit for your loved ones while accumulating cash value in your lifetime. Compared to a RILA, however, variable life insurance could involve taking more risk as there’s no guaranteed return.

Photo credit: ©iStock.com/nespix, ©iStock.com/shapecharge, ©iStock.com/Kirill Smyslov

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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