Here is a case study of a young financial professional who uses fixed indexed annuities and equity indexed annuities to shield his clients’ assets from market downturns.

Gregory Fortier, a financial analyst in Marshfield, Massachusetts with $120 million in client assets under management, built his career during the bull market that ended in March. As stocks steadily climbed, clients remained focused on the upside. Still, Fortier has long recognized that one of the most important rules for clients close to retirement is to de-risk their investment portfolios.  

“I’m not a believer in market timing,” says Fortier, a 31-year-old chartered financial analyst, affiliated with Centinel Financial Group. “You need to have a plan in place that you can implement that will work for you over the next five years or longer. What happens in the next five years can make or break your retirement plan,” he explains. “There’s an average outcome for investments, but there’s also tail risk on the downside and the upside. You could start with $1 million, win the lottery, and it turns into $10 million.” Or, if things go poorly, the $1 million could go down to zero.  

It’s almost as if the downside is unspeakable. But it always comes: The Great Depression, the oil embargo of the ‘70s, now the coronavirus. “Talk about a black swan event; we got one,” he says. “Most of my clients don’t need a ton more income. They just need protection on that asset base.” His go-to solution: He carves out a portion of their investable assets—typically one quarter to one third—into a combination of fixed indexed annuities and equity indexed annuities.  

Addressing two big risks

The goal, Fortier says, is to reduce or eliminate the tail risk exposure of a downturn—low-probability events that if they happen to have dire consequences to your retirement. Here’s how this worked in practice for three clients.  

Last year, in a portfolio review for a couple from Massachusetts with $1.5 million in investable assets, Fortier discussed the two big risks to their nest egg: looming retirement and talk of a recession. First, at 65 and 64, they both planned to retire in 2020, so they were only one-year away from retirement. Second, the bull market had been 10 years running. “How are we going to protect you from the inevitable?” Fortier says he asked them, noting that the downside risk became so much greater after the run up in the market.

The solution: The couple kept $1 million in stocks and bonds while putting $500,000 into a fixed indexed annuity. The $1 million remains liquid and accessible, but subject to market swings, up or down.  

By contrast, the fixed indexed annuity, with a five-year term works as a fixed income alternative. The fixed indexed annuity (FIA) tracks the S&P 500 Index but it has a minimum protected floor. If the S&P 500 is flat—or down—the couple would get back their $500,000. That’s guaranteed downside protection.  

Additionally, clients are protected from loss every year. And if the index is positive after a negative year, they have the opportunity to capture growth and no recovery is needed after a negative year. Since they didn’t lose money in the contract, they don’t have to make it back during the next calculation period.  

On the flip side, there is no guaranteed upside. They only win if the S&P 500 climbs, and chances are they’ll earn less than the market. If the S&P 500 is up, the couple is credited that upside, up to the cap. If the index goes higher, they don’t share in any gains over the cap. “It’s meant to preserve and grow the asset base,” Fortier says of the annuity.  

Keeping the nest egg safe

Yet the annuity can give the couple peace of mind. That chunk of their nest egg is safe. The annuity is a contract, guaranteed by an insurance company so when purchasing one, strong credit ratings, financial stability and longevity can be important considerations. The $500,000 is split between two annuities: $250,000 in his name and $250,000 in her name, for various planning reasons.  

At the end of the five-year term, the couple has options including starting income, renewing their contract for another term, or moving into another type of annuity contract. If they’re over 59.5, they could surrender and pay any taxes due at that time.  

Their remaining portfolio is allocated 60% stocks and 40% fixed income. Why so stock heavy? If you view the FIA as a fixed income alternative, the overall allocation is 40% stocks and 60% fixed income, a reasonable mix given the clients’ life expectancies and inflation prospects over that length of time.  

Fortier engaged another client three years away from retirement with a similar talk last year, but the California man stuck with his investments and decided not to go forward with the annuity at that time. In late March, when stocks were down 35%, the man called up Fortier asking for advice on his nearly $3 million nest egg: “‘Gee, I should have listened to you. I’ve been doing this on my own and I think I got overconfident.’ The COVID-19 crisis kind of woke him up to the importance of a plan,” Fortier says. He sees more do-it-yourselfers reaching out for advice given the volatility of the stock market.  

Overconfident investor

In the case of the California man, there was an added complexity: a big age difference between him and his wife. He’s 64 and his wife is 53. “She’s going to outlive him. It’s not fun to talk about, but we need a higher equity allocation to plan for that, to fight inflation,” Fortier says. That was one factor, in addition to the market decline, that led Fortier to recommend a buffered equity indexed annuity. If you expect a big recovery from a downturn, you don’t necessarily want to be limited to the lower earning cap on a fixed indexed annuity, Fortier says.  

The California man put $250,000 into an annuity with a cap rate of 150%, meaning he could more than double his money over the six-year term. That translates to a maximum annual growth rate of 16.5%. What about the downside? Rather than protect you fully on the downside like a FIA, a buffered equity indexed annuity protects you partially on the downside. In this case, he chose a 15% buffer. If the market drops 20% over the six-year period, the man is exposed to a 5% loss. “He gets an equity allocation with less inherent risk,” explains Fortier.  

Helping a younger client

A buffered equity indexed annuity can also make sense for someone who is younger. In another recent case, Fortier advised a new client from Illinois who had switched jobs five years ago, moved his workplace 401(k) plan to a bank account and left it in cash—all $800,000 of it—watching on the sidelines as the market moved up. “He started kicking himself,” Fortier says. In January, they settled on a strategy that would put $250,000 into an equity indexed annuity and move the rest into mutual funds and exchange traded funds over the course of six months. “He was nervous to invest. The annuity gave him the confidence to get in the market. There is some back stop there behind him,” Fortier says. He’s protecting part of his old 401(k) money while he’s building up his new 401(k) at his current job.  

“No one knows for sure and can tell you the S&P 500 is going to end the year at 3,500 or 3,800 by December 31. What if it doesn’t? What if it goes down another 30% or 40% and we’re in this prolonged recession, if it takes longer to contain COVID-19, or for the economy to get back on its feet?” Fortier says. He believes annuities, with downside protection, are a good way to chop off the tail risk of future black swan events.  

 

 

GE-XXXXXX (10/20) (Exp. 10/22)

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