Looking for options to make the most out of your investment options for retirement savings? Buffer annuities are a balance between growth potential and market risk protection. If you want secure retirement income and reduced risk to market downturns, buffer annuities might be worth a closer look.
What Is a Buffer Annuity?
A buffer annuity is a new type of structured annuity that provides market growth opportunities with built-in loss protection. Registered index-linked annuities are an example of structured annuities with a buffer.
It sets a “buffer” that absorbs a certain percentage of market losses to protect your investment during market downturns. With this level of protection in place, you can enjoy gains when the market performs well.
Buffer annuities are like variable annuities because they're directly tied to the market. However, unlike variable annuities, they cap both gains and losses.
Take a look at this buffer annuity example:
Let’s say you purchased an Allianz buffer annuity. If the market drops by 10% and your buffer is set at 10%, you won’t experience any loss. But if the market drops by 15%, your loss would be only 5%. You get partial protection, but exposure to higher potential gains.
2 Key Buffer Annuity Features
Buffer annuities have a unique structure to manage your risk and reward.
The Buffer
This is the main protective feature. It’s usually a set percentage that shields your investment from the first part of market losses. So, you don’t lose any value if the market drops 8% and you have a 10% buffer. However, if the market drops 15%, only 5% will impact your investment after the buffer absorbs the first 10%.
Cap and Participation Rate
While buffer annuities limit losses, they also cap your potential gains. This may not be ideal if you want to invest directly in the market, where you may have more flexibility than an annuity contract would allow.
This cap varies by the annuity provider, your contract, and overall market conditions. Some buffer annuities may also have a participation rate, a percentage of the index gain your annuity will earn. For instance, if your participation rate is 80% and the index gains 10%, your annuity would grow by 8%.
Buffers vs Floors in Annuity Contracts
When comparing buffers vs floors in annuities, you need to understand the purpose of each. Neither are inherently bad or good. Their application depends on your unique use case. Again, working with a financial fiduciary can help you determine which approach is best for your retirement goals.
Approach to Loss Protection
A buffer annuity absorbs a specified amount of market losses—like the first 10%. Any loss beyond that threshold impacts your investment. On the other hand, a “floor” sets a maximum limit on how much you can lose. If your contract has a “20% floor” you won’t lose more than 20% of your investment, even if the market drops 30% or more.
Growth Potential and Caps
Buffer annuities often have a higher cap on growth because they expose you to more potential market loss. A cap like this gives you higher participation in market gains, so keep that in mind.
Floors on annuities usually have lower caps because they provide a stronger protection level on the downside. You’ll have a tighter limit on how much you can gain in positive markets but a stronger guarantee in down markets.
Use Cases for Buffers vs Floors in Annuities
Are you comfortable with higher risk and some market loss? Buffer annuities may be suitable for you. They offer the potential for higher gains, which means more money in your pocket. That’s appealing enough to accept some level of risk.
However, if you consider yourself more risk-averse, you should consider another option. Floors in annuities will limit potential losses but have a lower cap on gains. They are useful if there are extremes in market downturns.
The Impact of Structured Annuities with Buffers
If you want moderate growth potential without the risk exposure of a full market investment, then consider this. Of course, consult with your financial advisor to determine if this approach is right for you.
While a structured annuity with a buffer seems attractive, you have to think about how the features will impact you and your beneficiaries.
Tax Treatment
When comparing it to other types of annuities, the tax treatment is generally the same. Like other types of annuities, buffer annuities offer tax deferral. Always keep in mind that tax deferral is not the same as tax avoidance—eventually you will pay taxes.
You just don’t have to pay taxes immediately.
Tax deferral might not be a great option for you if you end up in a higher tax bracket later on in life when you start making withdrawals.
Different Risk Tolerances
Depending on your annuity provider, you make have some flexibility with your structured annuity buffer. You can choose different levels of your buffer like 10% or 20%. Options like this give you some flexibility to choose the level of protection you’re most comfortable with.
Remember, if the market loss goes beyond the buffer, you will bear the remaining loss. You should seek a financial professional to help you determine what level would support your goals.
Bond Alternatives
If you’re looking for an alternative investment to something like a bond, then a buffer annuity is worth consideration. They are a relatively “safe” or conservative option. You can have more peace of mind because they don’t have direct exposure to interest rate risks.
Returns
A structured annuity with a buffer may give you higher potential for growth with protection, but other aspects can affect the money you earn. Buffer annuities can have surrender charges, complex fees and expenses, and terms, which may reduce net returns.
Also, with a buffer, annuity death benefits aren’t as secure as they would be with a traditional option. Many seek an annuity because it’s a guaranteed source of income for themselves and l beneficiaries. Being tied to a market means market volatility will affect returns, reducing the value for beneficiaries.
Plan for the Road Ahead
The road to retirement isn’t always smooth, so why don’t you accept some directions? Let the team at Asset Preservation Wealth and Tax help you find the best options to help you meet your retirement goals. Look forward to the rest of your life and your legacy with our comprehensive financial planning.
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Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the claims paying ability of the issuing company; not guaranteed by any bank or the FDIC.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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