Equity indexed products are becoming more popular in the face of market volatility and low interest rates. While they are not meant for everyone or every situation, there are many scenarios where indexed products may fit well into your client’s financial plan.
These products provide credits to annuity or life products that are tied to an outside index, such as the S&P 500 or the Russell 2000. In most cases, the credit to the account is guaranteed to be zero or positive even when the index decreases in value.
In today’s low interest rate environment, it may be difficult for your clients to meet their goals with typical guaranteed rate products. Here are situations where it might be appropriate for you to recommend an equity indexed product:
Retirees looking for well-defined points along the risk/reward spectrum
Retirees wanting stable year-by-year results and an underlying guaranteed level of lifetime income
Retirees with continuing protection needs who can enhance after-tax income potential with a properly structured indexed life insurance product
An equity indexed crediting product might be the answer for clients who need an opportunity for a higher return than pure guaranteed return products and are uncomfortable not knowing their absolute downside. Index products have a number of crediting methods that provide a choice from a variety of risk/reward tradeoffs that have a clearly defined guaranteed minimum and an upside tied directly to an observable index.
Crediting rates with higher participation in the indices’ price change may have lower caps on the upside. For example, an indexed annuity with 100 percent participation in the price change of the index might have a cap of 5 percent to 6 percent vs. one with 30 percent participation and no cap. In general, indexed life insurance products have higher caps but are assessed directly with cost of insurance charges.
Guaranteed level of lifetime income
You probably have already seen the growing popularity of Guaranteed Minimum Withdrawal Benefits (GMWBs), and most indexed products offer them as optional riders. These riders provide long-term certainty around income on top of the certainty of year-to-year minimum crediting rates.
Many clients who want certainty of retirement income will turn to certificates of deposit, but the value of CDs can be depleted long before typical life expectancy. In contrast, a GMWB guarantees a comparable level of lifetime income with no risk of outliving the benefit.
Let’s say you have a client who deposits $100,000 at age 60 and allows the assets to accumulate for 10 years before taking income. With a GMWB, the client will receive an income of about $13,000 per year, guaranteed for as long as he lives. Contrast that to a CD earning 2 percent to 4 percent.
Unlike insurance products, CDs are FDIC-insured and fully liquid. Given the same initial deposit and accumulation period, they can also produce about $13,000 per year. However, without the lifetime guarantees offered by the insurance product, the principal will deplete over time, and income will cease somewhere between age 80 and 82 if the rates don’t change.
Indexed life insurance
In today’s environment, indexed life products can provide an attractive mechanism to lower the long-term cost of permanent insurance without the volatility of variable products. An indexed universal life policy also can provide clients with both protection against early death and an efficient way to create after-tax retirement income. That’s because when structured properly, distributing from an IUL policy through a combination of loans and withdrawals can be made without triggering current tax.
Clients can maximize their after-tax income if they allow the death benefit to decrease to a lower level after eight to 10 years. This decrease coincides well with typical life insurance protection needs, which often decline as a working spouse nears retirement and even for a nonworking spouse, whose early death would create additional child-care expenses.
Indexed products can be useful tools to recommend as part of a conservative plan that has some opportunity for upside. Your clients can have a clear expectation of outcomes tied to readily observable indices and will have some idea of any possible downside.
Philip K. Polkinghorn, FSA, is senior executive vice president, Business Development, The Phoenix Companies Inc.