What Is A Registered Index-Linked Annuity (RILA)?

Registered index-linked annuities (RILAs) are an increasingly popular financial product for investors looking for exposure to the stock market with built-in protection from potential losses. 

But these annuities aren’t a panacea for retirement planning — they come with surrender charges and limitations on returns. Before you buy, you should know how RILAs work, their costs and whether they’re the right fit for your retirement portfolio.

What is a registered index-linked annuity?

RILAs are a type of deferred annuity, which means you make a series of payments over time to an insurance company, and in return, the insurer promises to give you a stream of payouts later, usually in retirement.  

RILA returns are based on the performance of an underlying stock market index, such as the S&P 500. Unlike fixed annuities, which offer guaranteed returns based on an interest rate, a RILA’s return fluctuates with the market. 

RILAs have become the rising star of the annuity industry. In the fourth quarter of 2023, RILA sales surpassed variable annuity sales for the first time, according to LIMRA, an insurance industry trade association. The momentum carried into 2024, with sales exceeding $62 billion.

How RILAs work

When you purchase a RILA, your money isn’t directly invested in the stock market. Instead, the insurance company tracks the performance of a chosen index and credits interest to your account based on the terms of your contract. These terms dictate how much of the index’s gains you receive and how much protection you have against losses. 

RILA contracts can be complex. A major challenge for consumers is the wide range of crediting methods used by different insurers, making it difficult to compare one product to another.

How RILAs protect against downside and limit your returns

Caps and participation rates restrict how much you can earn from a RILA. A cap sets a maximum return and caps usually reset after one or six years. So if an index rises 20 percent and the cap is 12 percent, you’ll receive 12 percent. 

An alternative crediting method to caps are participation rates. Participation rates determine what percentage of the index’s gains you receive. With a 70 percent participation rate, a 10 percent index gain would net you a 7 percent return.

One key advantage of RILAs is they offer higher caps on returns compared to fixed index annuities. But there’s a trade-off — you take on some risk beyond a set buffer or floor. The buffer typically absorbs the first 10 percent to 20 percent of losses, but after that, your account takes a hit.

For example, if your RILA has a 10 percent buffer and the market drops by 5 percent, your account remains untouched. But if the market falls 20 percent, the buffer covers the first 10 percent, and you absorb the remaining 10 percent as a direct loss to your account value.

A general rule of thumb with RILAs: If you’re willing to accept more risk via a smaller buffer, you may enjoy a higher cap on an index’s performance.

Another important consideration: Some RILAs give insurers the right to modify contract terms, including fees and interest caps, at any time. FINRA cautions investors to review their contracts carefully and understand whether the insurance company has the power to make these changes.

Cost of RILAs

Part of the appeal of RILAs is they typically don’t charge explicit fees, unlike many types of annuities. Instead, the costs are hidden in return caps and limited liquidity. 

Insurance companies work behind the scenes, often mixing bond investments with index-linked options to generate returns. So unless you’re an options whiz — and even then — it’s nearly impossible to gauge how much insurers pocket from selling these annuities. 

According to a review by the Securities and Exchange Commission (SEC), insurers profit by earning more on their investments than they pass along to investors.

While RILAs generally have lower fees than other types of annuities, they’re not fee-free. 

Surrender charges, for example, are a major pitfall. Most RILAs require you to lock up your money for five to seven years, and withdrawing funds early can trigger penalties (usually 7–10 percent) that decrease annually. 

Another drawback of RILAs — and annuities in general — is their tax treatment. While they grow tax-deferred in qualified annuities, accessing funds before age 59½ — just like with a 401(k) — triggers a 10 percent penalty from the IRS. 

RILAs vs. variable annuities

While both RILAs and variable annuities offer market-linked returns, variable annuities invest directly in mutual fund-like subaccounts, exposing you to full market risk. RILAs, on the other hand, limit downside exposure through buffers or floors but also restrict returns.

Variable annuities usually come with much higher fees, often ranging from 2 to 3 percent per year. These fees cover management costs, mortality and expense charges, and optional rider benefits. RILAs, on the other hand, tend to have few, if any, explicit fees, but both types of annuities still charge commission. 

RILAs vs. fixed index annuities

Fixed index annuities (FIAs) and RILAs both link returns to an index, but they differ in risk exposure and growth potential. 

FIAs usually provide full downside protection, so you’ll never experience losses or lose your principle, even if the index declines.

However, the upside potential for FIAs is much more restricted than RILAs, with lower participation rates and caps. For example, a FIA may cap your potential returns to 6 percent, while a RILA could credit you 10 percent of index gains.

Pros and cons of RILAs

Pros

• Downside protection: Buffers and floors help limit potential losses.
• Higher growth potential: RILAs typically offer better returns than FIAs.
• Tracks an index: Unlike variable annuities, which require you to pick from a confusing menu of underlying investments, RILAs link returns to a stock market index, such as the S&P 500.
• Customization: RILAs are highly customizable, so you can choose crediting methods, payout schedules and other features to suit your needs.

Cons

• Limits upside: Caps and participation rates restrict gains you’d enjoy if you had invested in the market directly through an index fund.
• Surrender charges: Long commitment periods make early withdrawals difficult and costly. So RILAs, and annuities more broadly, are considered illiquid investments.
• Complexity: Understanding the jargon of RILAs — including buffers, floors and participation rates — can be confusing.

Is a RILA right for you?

A RILA could be a good option if you want to enjoy some stock market gains with your retirement savings but still have some protection against losses. If you’re investing for the long-term and don’t need quick access to your money, a RILA can help you grow your savings in a structured, tax-deferred way.

That said, RILAs aren’t right for everyone. If you want full protection from losses, a fixed index annuity might be a better choice. And since these annuities come with surrender charges, you’ll want to make sure you won’t need to withdraw your money ahead of schedule.

Before buying a RILA — or any annuity — make sure to ask the agent or advisor to clearly explain all the terms in the contract, including how much upside will be credited to your account and how long that rate will last. Don’t hesitate to call in outside help either and talk through your options with an independent financial advisor.

Bottom line

A registered index-linked annuity sits between safe annuities and riskier stock market investments, giving you a mix of protection and potential returns. But because RILAs come with confusing rules and penalties for early withdrawals, you need to understand the trade-offs before investing. Talking to a financial advisor can help you weigh the pros and cons, and decide if a RILA fits into your long-term retirement strategy.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.