Why Fixed Indexed Annuities Are Back

The options budget is based on the yield of the Moody’s Seasoned Aaa Corporate Bond index.

In November 2021 (roughly one year ago), estimated caps were around 5%, consistent with actual products available at the time. Caps have roughly doubled since then (i.e., are around 10% now), but are still below where they were before the global financial crisis (e.g., in 2006), when they exceeded 15%.

Caps were estimated to be as low as 3% in July 2020 and hovered around 4% for most of 2020. This relatively limited side made the products relatively unattractive at the time, in my opinion, versus other more vanilla strategies (e.g., just shifting more of a portfolio into equities) or other strategies that could offer higher fixed returns that are less complex (e.g., multi-year guaranteed annuities, or MYGAs).

The recent improvement in caps has changed the equation, though. The higher FIA caps available today present a decent amount of upside for someone who likes the idea of market participation but wants to do so without the risk of losing money (i.e., is risk averse).

FIAs also benefit from tax deferral when purchased in a taxable account. Taxes are an increasingly important consideration in a higher bond yield environment, especially among more conservative investments, like bonds, that typically have unfavorable taxation (i.e., all gains are realized annually and taxed at ordinary income levels).

While FIAs do have an equity component, it’s important to realize they are far more bond-like than stock-like when including in a portfolio.

The Rise of Rates

Financial advisors need to be continually reevaluating the product landscape to ensure they are building the best strategies possible for clients. This is especially true today, given the notable increase in bond yields, which also has other important implications for issues like taxes.

Fixed indexed annuities are an example of a product that has benefited significantly from the recent rise in interest rates to the point where they are worth considering for the right client.

David Blanchett is managing director and head of retirement research for PGIM DC solutions, an adjunct professor of wealth management at The American College of Financial Services, and a research fellow for the Retirement Income Institute.