Sweep the Gains from Equity Positions Into an FIA

For Investors on the glide path to retirement, they have a nine-year bull market to thank for rescuing their retirement plans. In 2017, the surging stock market produced double-digit gains in all sectors except energy, which means, if you were invested in stocks, you did well. For pre-retirees preparing to transition into retirement over the next five to ten years, it may be the perfect opportunity to lock in some gains and protect them to maximize future income.

When Your Portfolio Needs Rebalancing

The typical investment practice of re-balancing a portfolio calls for selling equities that have achieved or exceeded their target price and then buying equities that have greater upside potential. While that is a prudent and proven practice for maintaining your target asset allocation, there is the risk that a change in market direction could drag the overall portfolio value down. What if you could protect the gains of appreciated stocks or mutual funds in return for moderate returns but with the opportunity to grow them further when the market rises? That could be the effect of sweeping your equity gains into a flexible premium fixed indexed annuity (FIA).

How a Fixed Indexed Annuity Works

With an FIA, your principal is guaranteed not to lose value, but it participates in the growth of the stock market. In other words, there is no downside risk – only upside potential. However, in exchange for that downside protection, the upside potential is limited. If the market retreats by 15 percent, which would be a normal correction following the kind of market surge we have experienced recently, your principal value would not decline. If the market continues on its current trajectory and increases by another 15 percent, a typical FIA would cap your return at around 4 to 6 percent. However, once you are credited with a gain, it is forever locked in. Most FIAs guarantee a minimum interest rate of between 0 and 3 percent.

To accomplish that, insurers use the portion of the gain that is not credited to your account to purchase options on the underlying index. The use of options allows the insurer to capture the market’s upside while limiting its downside. The use of participation rates and cap rates in determining how much of a gain is credited to your account is somewhat complicated, but, used in conjunction with the option strategy, they are key to the guaranteed protection of your principal and your gains.

Don’t Just Lock in Your Gains – Grow Them

Going forward, the gains you realize in your equity portfolio and sweep into an FIA would only continue to grow, albeit at a slower pace. The possibility of earning a return two to three times the rate of a Treasury bond, or four to five times the rate of a CD, without any downside risk is more than acceptable to investors who have experienced more than enough volatility in their retirement portfolios. The funds inside an FIA accumulate tax-deferred until they are withdrawn when they are taxed at ordinary income tax rates up to your principal amount which is not taxed.

Access to Your Funds and Guaranteed Lifetime Income

When the accumulation phase ends, you can either start making withdrawals or convert the FIA into a guaranteed income stream you can’t outlive. The longer you wait to start taking income from your FIA, the higher the guaranteed minimum amount of income you will receive. Withdrawals taken during the surrender phase of the FIA – typically between the first and 10th year – are subject to surrender fees if they exceed 10 percent of the account value. After the surrender period, withdrawals of any amount are free. By adding a lifetime income rider when you first purchase an FIA, you can guarantee a fixed monthly income for life that is guaranteed to grow the longer you delay accessing it.

The Ideal Transition Strategy?

This FIA strategy may not make sense for everyone, especially those who still feel as though they can continue to assume the risk of staying completely with equities. However, if you are on the edge of transitioning into retirement, and would like to taper off your exposure to market risk, an FIA is an effective vehicle for locking in your gains, protecting them, and having them continue to grow moderately.

Considering everything FIAs can accomplish for you, they are complex vehicles to understand. As with any type of investment vehicle they have their pros and cons. However, considering everything they can accomplish for you, they are worth the time to learn how they can work in your situation.