With markets trying to recover from a bear market, investors may be asking: “How do I protect myself from the downside?” This article discusses using life insurance, annuities, ETFs, and notes to participate in market upswings with downside protection.[1]
Life insurance
A vehicle to participate in market gains and limit losses is the Equity-Indexed Universal Life policy (IUL). An IUL invests a portion of the cash value in options that track a stock market index without dividends. An index fund’s success depends on the index tied to it, but there are no guarantees the funds will grow. With IUL, the policyholder participates in gains of the underlying index while limiting downside exposure.[2] Gains are capped (cap rate) and market losses are limited (crediting floor).[3] This policy should only be funded up to IRS limits to have income tax free loans. Recent tax changes enable higher contributions into life insurance policies while minimizing the death benefit.
Annuities
Equity indexed annuities also offer participation rates based on a benchmark’s performance; however, their limited market gains may make utilizing the life insurance structure above more attractive, with its higher cap rates. Fixed annuities offer return of principal and are attractive when compared to CD rates but do not offer as much appreciation potential.
A lesser-known annuity to consider is the Registered Index Linked Annuity (RILA), sometimes called a “buffer annuity”, which also captures limited market gains (with a cap rate). RILAs are generally tied to performance of a market index, while providing a protection level (“buffer”) for negative index returns. However, owners are not directly invested in either an index or the market. If the market goes down by more than the buffer percentage, the owner will lose money exceeding the buffer.
Owners can select their investment time horizon. An annuity with a dual directional feature allows potential profits even in down markets. For example, an investment can track the S&P 500 index today with a 10% one-year cap rate and 10% dual directional feature, and if the market rises or falls 10%, an owner would make 10% before fees. Some products may have a step rate feature so that when the market goes up 1 penny, you can receive a favorable return. Some of these annuities can provide income.[4]
Notes and ETFs
Structured notes and exchange traded funds (ETFs) may provide additional ways to participate in the market and potentially limit downside risks. Products of some issuers offer market participation where you can earn money up to a cap rate and have a buffer percentage that limits loss. Seek ETFs with good liquidity. The ability to trade after issuance can occasionally create interesting pricing differences between index performance and the price of the ETF. Multiple issuers track different indices with varying cap rates over different time frames. Before buying an ETF, consider its investment objectives, risks, charges, and expenses.
Summary
During volatile markets, it makes sense to know how to participate in market gains while having downside protection. Innovative use of these products may help people reach their goals with downside protection.
[1] These products may suit some, but risks, costs, and restrictions won’t benefit every plan. If interested in these products, consult your financial professional, gather and review the prospectus and other documentation before purchase.
[2] The amount in the insurance policy is subject to the claims paying ability of the insurance company
[3] This product and the products discussed below look at an index today and at some snapshot in time and provide the appreciation in the index from one point to another without paying dividends. The examples provided are for illustrative purposes only.
[4] A financial professional can help you pick an investment time horizon, understand how performance is measured and learn the levels of protection available. Variable annuities are sold by prospectus only, which contains more complete information about the policy, including risks, charges, expenses, and investment objectives. You should review the prospectus carefully before purchase.
Steven Hein C.P.A., J.D., M.B.A, LL.M., PFS, CFP of Hein Wealth & Tax Soultions LLC is an independent financial planner. He works with individuals, families and business owners to help them develop a strategic, long-term financial plan that helps them achieve their financial objectives. He helps clients fully understand all of their options.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Hein Wealth & Tax Solutions is not affiliated with Kestra IS or Kestra AS. Kestra IS nor Kestra AS and Hein Wealth & Tax Solutions LLC, are not Certified Public Accounting (CPA) firms. Registered Persons may be properly licensed as Certified Public Accountants (CPAs) to practice such activities outside of their capacity as Registered Persons. Kestra IS & Kestra AS do not provide tax or legal advice.