If your 401(k) has experienced significant growth, you may be wondering whether it is time to protect some of those gains.
Two options you may hear about are a fixed indexed annuity, commonly called an FIA, and a registered index-linked annuity, or RILA. Both can provide index-linked growth, but they offer very different levels of protection.
The right choice depends on whether your priority is maximizing growth, limiting losses, or completely avoiding market losses on that portion of your retirement savings.
Need help choosing the best annuity for your unique situation? Have questions about getting an annuity? If so, it’s best to speak with an annuity specialist. Watch this short video to see how I can help you do this (at no cost to you!)
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What Is the Difference Between an FIA and a RILA?
A RILA allows you to participate in some market-linked growth while accepting a limited amount of market risk.
Many RILAs use a buffer or floor to determine how much of a market decline the insurance company absorbs and how much you absorb. The exact protection varies by contract.
In exchange for accepting some losses, a RILA may offer higher growth potential than a fixed indexed annuity.
A fixed indexed annuity works differently. Your money is not invested directly in the stock market, so a negative index return generally will not reduce your account value.
Instead, the insurance company credits interest based on the performance of an external index, subject to the contract’s caps, participation rates, spreads, and other limitations.
You may not receive the full return of the stock market, but you also do not participate in its negative returns.
Keep in mind that withdrawals, surrender charges, income-rider fees, or other contract charges can still reduce the value of an annuity. The protection applies specifically to losses caused by negative index performance.
Why an FIA May Help Protect Your 401(k) Gains
Suppose your 401(k), IRA, TSP, or 403(b) has been invested in the market for many years and has accumulated substantial gains.
You may still want growth, but you may no longer be comfortable exposing all of that money to another major market decline.
That is where a properly selected fixed indexed annuity may help.
When the selected index has a negative year, your credited interest will be zero rather than negative. When the index rises, you may receive a portion of that growth based on the contract’s crediting method.
I often describe it as a staircase instead of a roller coaster.
Some years may be flat. Other years may move upward. However, you are not relying on future gains simply to recover from previous market losses.
💡 Pro Tip: An FIA is not designed to outperform the stock market during every bull market. Its primary purpose is to provide protection from negative index returns while still offering the opportunity to earn interest.
👉 Want help comparing fixed indexed annuities for protecting your retirement savings? Schedule a call with me.
Why FIA Returns Are Limited
The insurance company limits how much index growth is credited to your contract.
This may be done through:
- A cap rate
- A participation rate
- A spread
- A combination of different crediting limits
For example, a participation rate determines what percentage of an index gain is used when calculating your credited interest. A cap places a maximum on the amount that can be credited during a particular term.
These limitations are part of the trade-off for market-loss protection.
You should not expect to receive every percentage point earned by the S&P 500 or another index. However, when the index falls, you also avoid participating in that negative index return.
That trade-off can become increasingly attractive as you approach retirement and have less time to recover from a major market decline.
Choosing the Right FIA Matters
Not every fixed indexed annuity is a good option.
There are thousands of product variations available, and different annuities are designed for different goals. Some are designed primarily for growth, while others are designed to produce guaranteed lifetime income.
If growth is your priority, I look closely at factors such as:
- Current cap and participation rates
- The indexes available
- The insurance company’s renewal-rate history
- Contract fees and surrender periods
- The carrier’s financial strength
- Available liquidity and withdrawal provisions
The highest introductory participation rate does not automatically make an annuity the best choice.
A company might offer an attractive rate during the first year and reduce it later. That is why renewal-rate history and the overall quality of the contract are extremely important.
I work with many different carriers because I do not believe someone should be pushed into one product simply because it is familiar or pays the agent a higher commission.
The goal is to compare the available options and find the product that best fits what you are trying to accomplish.
Should You Choose an FIA or a RILA?
A RILA is not necessarily a bad product. It may be appropriate for someone who wants more growth potential and is comfortable accepting a clearly defined amount of market risk.
However, it is important to understand that a RILA does not provide complete protection from market losses.
A fixed indexed annuity may be more appropriate when your priority is protecting your accumulated gains from negative index performance.
My preference is often to clearly separate, or compartmentalize, different parts of a retirement portfolio.
Money intended for maximum long-term growth can remain invested in assets that carry market risk. Money intended for protection or guaranteed income can be placed in products designed to provide those guarantees.
This can make it easier to tolerate volatility in your growth portfolio because another portion of your retirement plan is protected.
The best answer may not be putting everything into an FIA or leaving everything in the market. It may be finding the right balance between growth, protection, liquidity, and retirement income.
What If You Also Need Guaranteed Lifetime Income?
Some fixed indexed annuities are designed primarily for accumulation. Others include an income rider that can provide guaranteed lifetime withdrawals.
For example, the illustration I used in the video above showed a 65-year-old placing $500,000 into an income-focused annuity and waiting five years to begin income. The illustrated lifetime payout was approximately $61,000 per year beginning at age 70.
That does not mean every person will receive that amount. Payouts depend on factors such as:
- Your age
- Your state
- The amount deposited
- How long you wait before taking income
- Whether income covers one person or two
- The specific carrier and rider selected
An income-focused annuity should not be evaluated the same way as a growth-focused annuity.
With an income annuity, the primary objective is purchasing a contractual lifetime income stream. The account value may eventually decline or reach zero after withdrawals and rider charges, but the guaranteed income can continue for life, subject to the insurance company’s claims-paying ability.
If your priority is accumulation rather than income, I would compare products designed specifically for index-linked growth without automatically adding an income rider you may not need.
Conclusion
A RILA may offer more upside potential, but you must be willing to accept some market losses.
A fixed indexed annuity generally offers less growth potential than being fully invested in the stock market, but it can protect your account from negative index returns.
For someone who has accumulated substantial 401(k) gains and wants to protect a portion of that money while retaining some growth potential, the right FIA can be a strong option.
The most important part is selecting the right carrier, index strategy, crediting method, and contract structure. There is no single annuity that is best for everyone.
Before moving money from a 401(k), you should also confirm that you are eligible for a rollover and review the transfer with a qualified tax or financial professional. A properly completed direct rollover can generally preserve the tax-deferred status of the money.
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