What is a RILA? Should You Buy One?
RILA annuities are all the rage right now. What is a RILA and should you buy one?
First off, the “A” stands for annuity. So it is a RILA, not a RILA annuity!
These annuities are taking off from a sales perspective, and so I’m not surprised that you are being sold a RILA. Should you buy one?
Let’s find out!
What is a RILA?
A RILA (registered index-linked annuity) is similar to a FIA (fixed indexed annuity). Both use options on stock market indexes to provide a return, and both limit loss of principle.
Further, both are types of deferred annuities aimed at accumulation. FIAs have principle protection—there is no risk of principle loss, though likely they won’t return nearly as much as advertised over the next few years.
With a RILA, you can dial up and down the risk you are willing to tolerate.
That is, RILAs are like buffered ETFs where there is a downside buffer. And in fact, prior to becoming registered index-linked (who actually knows what that means???), they were often called buffered annuities.
RILAs must be sold by folks who have a security license (the registered part of the name), so they may be pitched as an alternative to VAs (variable annuities) rather than FIAs (you don’t need a security license to sell FIAs, just an insurance license). So, in effect, you might see your bank or broker dealer pitching you a RILA (or a variable annuity), whereas your insurance salesman will continue to pitch you a FIA (unless they also have a securities license).
I’m assuming you know a bit about annuities at this point. If you don’t, then you don’t want to buy a RILA! I’m actually pro annuity (in general), so start with 18 reasons to own an annuity if you need to.
Let’s look at how RILAs compare to FIAs and VAs.
How Do RILAs Compare to FIAs and VAs?
RILA vs FIA
As mentioned above, you need a security license to sell a RILA. You don’t with FIAs. FIAs actually don’t lose money (there is true principle protection), but there is only a downside buffer or floor for a RILA. You might make more with a RILA than a FIA because you have more risk, or specifically, less downside protection.
RILA vs VAs
VAs are chock full of fees (with the general exception of IOVAs) and actually invest in the stock market via subaccounts. RILAs use options rather than actual investments in stocks and bonds. VAs seldom are indicated, yet they remain the bestselling annuity year after year.
RILA vs MYGA
MYGAs are also accumulation products, but the interest is fixed. MYGAs are similar to CDs (but they are annuities!) and have very favorable rates right now compared to CDs. There is no downside risk with MYGAs, whereas you may earn more (and lose some) with a RILA annuity.
Next, how do RILAs work?
How Do RILAs Work?
RILAs use a rather complicated series of options. Remember, complicated favors the seller rather than the buyer. Once you buy one, the downside (floor or buffer) is pretty much locked in for the duration of the contract (usually 6 years), but the insurance company can change the cap. They make their money on the spread between what they earn and what they give you with the cap. The salesperson earns commission because of the surrender charges which lock you up on the produce for (usually) 6 years. Most do not have “fees” associated with the product, but you can be sure the salesperson and the insurance company makes money with these products.
So, how do RILA annuities work?
On the upside, there is a cap, where you participate in the upside of a market index via options (you don’t actually own the stocks, just options to purchase the stocks if they go up). It is important to remember that you do not get dividends when you only own options on stocks.
The downside is a bit more complicated. There is either a buffer or a floor.
Above, with a buffer, you are protected from the downside for a while, and then you are fully exposed to any further losses. Since the downside is unlimited, you often have higher caps with buffer RILAs. As an example, if the buffer was 10% and the market went down 30%, you would lose 20% (30 minus the buffer).
With a floor, you assume the initial risk of a down market, and then you have protection below the floor. Since the insurance company assumes the largest downside risk, you usually have lower caps with floor than with buffers. As an example, if the floor was 10% and the market goes down 30%, you would lose only the floor (10%) and no more.
So the floor is the absolute most you can lose, and a buffer absorbs part of your losses before you start taking them again.
I’m not going to get into how options are specifically used for these products, because if you understood that, you could make your own product rather than having to buy one from an insurance company! (If you want to understand them, see my bit on buffered ETFs, link below.)
What might you want to use a RILA?
Use Cases for a RILA Annuity
There are few actual use cases for a RILA annuity. This is why you are being sold one. There are annuities (good annuities) that you actually have to seek out and buy. This is not one of them, as most of the time, you will be better off actually investing in a diversified portfolio.
That said, there are use cases for RILAs. Please see my bit on Buffered ETFs for use cases of buffered annuities. The use cases are similar to the use cases for RILAs. ETFs are generally superior in almost every way to an annuity, unless you actually plan to annuitize the contract.
With RILAs, there are surrender charges usually for the first 6 years. This actually does provide you an illiquidity premium, and, on average, you see higher caps with RILAs than you do with similar ETFs.
Given the complexity of these annuities, for the most part you should avoid them unless you perfectly understand what you are getting yourself into.
Especially if we are talking about a qualified RILA!
IRA or Brokerage Account: Qualified vs Non-Qualified RILA
One of the main advantages of annuities is that they are tax-deferred. Of course, qualified (retirement)-type accounts are already tax-deferred, so be very careful before considering a qualified RILA. Specifically in your IRA: avoid RILAs.
In your non-qualified (or brokerage account), you pay ordinary taxes on the gains from a RILA but capital gains on the gains from and ETF. Also, with an ETF, you defer taxes until you sell, so that is not a huge advantage for non-qualified RILAs.
So, when might you consider a RILA rather than a buffered ETF?
When might you want a RILA rather than a buffered ETF?
IF you are considering annuitizing the annuity for income, you might consider a RILA.
Otherwise, RILAs can have higher caps due to the illiquidity premium, and you might be less tempted to sell the product due to the surrender charges in the first 6 years.
In general, both RILAs and Buffered ETFs are there if you have behavioral problems with investing you are trying to address. See my blog on buffered ETFs for a full discussion and examples of the behavioral problems that RILAs attempt to address.
Taxation of RILAs
Of course, like all annuities, growth from RILAs is taxed as ordinary income. Growth is tax deferred until you sell, but you can always 1035 exchange to other products.
With a buffered ETF, you have tax-deferred growth until you sell, then you pay long term capital gains (if held for more than a year).
Ranking the Risk of RILAs
Let’s look at the risk of the deferred annuities and force rank them, and also see what “usual” investment to which they are similar.
MYGA >> FIA >> RILA (Floor >> Buffer) >> VA
(CDs) (structured investments) Buffered ETFs Mutual funds
MYGAS are least risky; about as risky as CDs. Both are principle protected and have fixed rates of growth.
FIAs are similar to structured investments. The goal is to be a bond-alternative and have more growth than just bonds, but also principle protection. The world of structured investments quickly becomes overwhelming, and there are many products which are more like RILAs than FIAs.
Next, RILAs can be compared to buffered ETFs. Floors are more on the conservative side, and buffers more aggressive. You can find all the same options for buffers and floors with buffered ETFs as well.
Finally, VAs might be compared to mutual funds. With both, you have the usual market risk.
Summary: Are you Being Sold a RILA Annuity?
In summary, annuities are mostly oversold. They are complicated, and you really must understand the details before you consider purchasing one.
Above, you can see a FIA compared to a RILA with a floor and with a buffer.
You might have a higher cap if you use a buffer, because as you can see you are exposed to more risk.
As is usually the case with these products, you are better off being in a diversified portfolio of stocks and bonds. If you can not commit the cardinal sin of investing (not selling low), nothing beats owning and loaning to the whole economy of the world.
You might consider a FIA if you have a tendency to panic and sell low, and want bond-like returns. FIAs are true bond-alternatives.
With RILAs, you can dial up and down the risk by selecting a product with the risk characteristics you want. RILAs with floors are more like bonds than those with buffers, but the specific details of the products are important.
If you are being sold a RILA, remember to always think about the purpose of the money. There will be folks who understand and want to purchase RILAs, but not many. Many more will be sold.