Indexed Income Plans – Are They Suitable For You?
There has been a noticeable increase in indexed income plans being introduced in Singapore recently. I have also noticed more clients hearing about these plans through banks, insurers, financial advisers and advertisements.
It is not difficult to understand why. Markets have been trading at high levels. People still want to participate in future growth but at the same time, there is naturally some concern about investing after markets have already done well.
During one of our recent client update sessions, we discussed indexed income solutions because we felt it was important for our clients to understand how these plans work before deciding whether they should have a place in their financial plan. A common way clients describe these plans to me is when markets rise, they want to participate in the growth but when markets fall, they would prefer not to suffer the same negative return. Often, when we look deeper into the financial product being described, it turns out to be some form of indexed income plan.
It does sound attractive. But as with most financial products, I believe the more important consideration is not simply whether the product is “good” but whether it is suitable for your financial goals and what role it should play in your overall retirement plan.
What Is An Indexed Income Plan?
In simple terms, an indexed income plan is an insurance policy where the potential return is linked to the performance of one or more market indices. You are generally not buying the index directly. Instead, you are buying a policy issued by an insurer that has its own terms, charges, guarantees and rules.
The insurer then uses the performance of a market index or index strategy as a reference to determine how much return may be credited to your policy. The “income” part is also important. Ultimately, especially when we are planning for retirement, we do not invest simply to watch the value of an account grow. Eventually, those assets need to provide us with an income. Some indexed income plans therefore allow the accumulated policy value to support future withdrawals or an income stream.
How Does An Indexed Income Plan Work?
At first glance, indexed income plans can sound quite complicated because there are terms such as participation rate, floor rate and index crediting. So I usually explain how they work in four steps.
1. Pay The Premium
You first place a sum of money into the indexed income policy. Your money is not simply being used to buy the shares inside the S&P 500, Nasdaq or another market index. You own an insurance policy and the insurer determines how the policy works according to its terms and conditions.
2. Follow An Index
The policy then references the performance of an index or index strategy offered within the plan. The index becomes the reference point for calculating the potential return. If the chosen index performs well during the measurement period, there may be a positive return credited to your policy. However, if the index rises 10%, this does not automatically mean your policy earns 10%.
3. Apply The Policy Rules
This is probably the most important part to understand. Every indexed income plan has its own crediting rules. One example is the participation rate. For example, if an index rises by 10% and the policy has a participation rate of 120%, the index-linked calculation may use 120% of that index gain, subject to the other rules and terms of the policy. Different plans can have different participation rates and formulas. The other feature that usually attracts even more attention is the floor rate. Some indexed income plans may provide a 0% floor. This means that if the index performs negatively during that particular measurement period, instead of receiving a negative index-linked credit, the policy may credit 0%.
4. Credit The Return
After applying the policy rules, the insurer determines the amount to be credited to the policy. If the index performs positively, you may receive a positive credit according to the policy formula. If the index performs negatively and there is a 0% floor, the index-linked credit may be 0% instead of a negative amount. The process then starts again for the next measurement period.
So perhaps the easiest way to understand an indexed income plan is that you are not investing directly into the market index. You are buying a policy that uses the index as a reference and the policy rules determine how much return is eventually credited to you. That is why understanding the terms and conditions of the policy is just as important as knowing which index it follows.
What Does A 0% Floor Really Mean?
This is probably the feature that catches most people’s attention.
You may see descriptions such as: “Protection against negative returns with a 0% floor”. To understand what this means, suppose you choose a strategy linked to the S&P 500. If the index declines by 10% during that measurement period and the plan provides a 0% floor, you may receive 0% index-linked credit instead of -10%. In simple words, your policy does not fall by 10% simply because the referenced index fell by 10%. There is just no additional index-linked growth for that period. This can certainly be attractive.
However, it is important to note that a 0% floor does not automatically mean that you cannot lose money under any circumstances. There may still be policy charges or deductions. There may be surrender costs if you take the money out early. There may also be currency risk, particularly when the policy is denominated in another currency. Illustrated benefits are also not necessarily the same as guaranteed benefits. It is important to understand exactly what is being protected. The floor may protect the index-linked crediting calculation. It does not remove every risk or cost within the policy.
The floor may protect the index-linked crediting calculation but it does not remove every risk or cost within the policy. As with most financial products, there are trade-offs. Some downside protection may come with limits on upside participation, liquidity or flexibility.
Why Are Indexed Income Plans Becoming So Popular?
From what I am seeing, there are five main reasons why these plans are becoming more popular.
1. Markets Are At High Levels
People still want to invest and participate in market growth. But when markets have already done very well, there is naturally some concern about buying at the wrong time and experiencing a market correction soon afterwards. That is why a plan that allows some participation in market growth while providing some protection if markets fall can be attractive.
2. Cash May Not Be Enough
The other option is to leave the money in cash. But cash has its own limitation. Inflation continues to be an issue and over time, cash alone may not be enough to meet future retirement or legacy needs. For retirement planning especially, the money we need in future will probably cost more. Thus, while we want to protect our money, we also need some growth.
3. Our Future Income Needs Are Rising
Besides inflation, our future expenses will continue to increase. That means that the income we need in retirement may also need to grow over time. This becomes especially important because retirement can last 20 or 30 years. What is sufficient when we first retire may not be sufficient many years later. This is why I am always looking for a good balance between protection and growth when planning for clients.
4. Protection Plus Growth Is Attractive
I think this is one of the main reasons these plans are getting attention. Many clients still want some opportunity for their money to grow but at the same time, they may not want to take the full downside risk of investing directly into the market. Indexed income plans try to provide that middle ground as it provides some growth potential together with some downside protection.
5. There Are More Options Now
Another reason is simply that more insurers are entering this space. There are now more indexed solutions available so naturally clients are hearing about them more often through banks, insurers, financial advisers and advertisements. More such products create more awareness and more conversations.
The popularity is understandable. But I think popularity does not mean suitability. Just because a financial product is popular does not mean that you should buy it. The more important question is whether it is suitable for your financial goals, liquidity needs and risk profile.
A Similar Conversation Is Happening In The US
I recently came across an interesting post by Tom Hegna, a US retirement income expert whom I follow on the growing interest in indexed annuities among younger investors. What caught my attention was that these solutions are no longer being discussed only for people who are already close to retirement. He also highlighted that fixed indexed annuities in the US can provide market-linked upside together with principal protection.
I find this interesting because it reflects the same planning issue we are seeing here. People still want their money to grow but at the same time, they are becoming more conscious of how much downside risk they are prepared to take. Of course, the fixed indexed annuities discussed in the US are not exactly the same as the indexed income plans available in Singapore. The structures, guarantees and regulations are different. But the underlying planning need of finding a suitable balance between growth and protection, especially when we are building future retirement income is similar.
Looking At Indexed Income Through The Lens Of Financial Planning
A financial product should not be considered in isolation. It should complement your overall retirement plan. There are four possible uses of indexed income plans: Retirement income, capital preservation, legacy planning and portfolio diversification.
For someone who has already accumulated sufficient wealth, capital preservation may become more important than maximising every dollar of return. Because these solutions are also insurance policies, some plans may also have features that can support legacy planning. And for someone who already has significant direct exposure to shares and other market investments, an indexed income solution may potentially provide another form of diversification.
Where Does Indexed Income Fit Into Our Retirement Planning Approach?
When I work with clients on retirement planning, I generally think about retirement income in two phases. I do not believe retirement planning should simply be about accumulating the largest possible nest egg. Eventually, those retirement assets need to provide income.
Phase 1: Reliable Income For Basic Needs
The first retirement goal is to create enough low-risk or reliable income for basic living expenses. For Singaporeans, CPF LIFE is usually an important starting point. Private annuities and other predictable income sources may then complement CPF LIFE where there is still an income gap.
Your basic expenses do not disappear because markets are down. Food still needs to be paid for. Utilities still need to be paid for. Healthcare still needs to be paid for. Greater certainty is preferred for this retirement income for essential retirement expenses. This is because your essential retirement expenses should not depend entirely on whether investment markets happen to be doing well that year.
Phase 2: Growth Income For Inflation And Lifestyle
Once the basic income has been sufficiently provided for, we move to the second phase. This is what I call growth income. The goal is to build a second layer of retirement income that has some potential to appreciate over time and help provide for inflation and lifestyle. This is important because retirement can last 20 or 30 years. Even if S$5,000 a month is sufficient when you first retire, the same S$5,000 may not provide the same purchasing power 10 or 20 years later.
There are also lifestyle expenses such as travel expenses, dining expenses, hobbies and family experiences. These may not be basic necessities but they are part of the retirement lifestyle many of us are planning for. This is why I generally structure retirement income planning in two phases:
Phase 1 – Income for basic needs
Phase 2 – Growth income for inflation and lifestyle.
Indexed income plans may have a role in the second phase.
Indexed Income Can Be Used For Phase 2 Planning
For retirement planning, I would not position an indexed income plan as the foundation for essential retirement expenses. You should make sure there is sufficient reliable income from CPF LIFE, annuities and other predictable sources to provide for basic needs.
Once that is in place, we can then look at Phase 2 of the planning. An indexed income plan may have a role here because it gives the retirement portfolio another way to participate in market growth without having the same direct exposure to market declines for that portion of the money. For example, if part of your Phase 2 retirement income is invested directly into equities, the value can fluctuate quite significantly from year to year. This may be easier to accept when you are still working and have many years before you need the money. However, once you are approaching or already in retirement, the experience can feel quite different because you may also be relying on that portfolio to provide income.
This is where the downside protection of an indexed income plan may become useful. If the referenced index performs negatively during a measurement period, a 0% floor may mean there is no negative index-linked credit for that period. At the same time, when the index performs positively, there is still the potential for the policy to receive a positive credit based on its participation rate and other policy rules.
For some clients, an indexed income plan may provide another way to build Phase 2 growth income as it provides income that can potentially grow over time to help with inflation and lifestyle spending while reducing the reliance on having all of that money directly exposed to investment markets. This is also why I see it more as a portfolio diversifier rather than a replacement for the investment portfolio.
Your existing investments may still be very important for long-term growth. In fact, some clients may already have sufficient investments, SRS assets or other retirement assets to provide the growth income they need. If that is the case, there may be no need to add an indexed income plan. For another client, however, the retirement portfolio may be heavily dependent on direct market investments. In that situation, allocating a portion to an indexed income solution may provide a different balance between growth potential, downside protection and future income.
This is why we would not look at an indexed income plan on its own. We would first look at the income you already have, the investments you already own and how much Phase 2 growth retirement income you still need. Only then can we decide whether an indexed income plan adds something useful to the retirement plan. The question is not whether indexed income is better than investing. It is whether having both can create a better balance for your retirement income needs.
Who May Find An Indexed Income Plan Suitable?
From a financial-planning perspective, I would generally look for a few things. The money should be for long term planning. There should already be sufficient liquidity elsewhere. The client should understand how the index-crediting strategy works, what is guaranteed and what is not and what may happen if the policy is surrendered early.
Any currency exposure should also be understood. And importantly, the client should be comfortable with the trade-off between downside protection and potentially giving up some of the full market upside. It may therefore be less suitable for someone who needs the money in the short term, wants the full return from investing directly into the market or is mainly attracted by an illustrated return.
This brings me to what I think is the most important part.
Before Buying Another Financial Product, Start With What You Already Have
Before deciding whether you need an indexed income plan, you should first consolidate your existing retirement income sources. You may already have CPF LIFE, private annuities, SRS assets, investment portfolios, rental income, endowment plans, savings or other assets that can eventually provide retirement income. Until we put everything together, it is difficult to know what is missing.
For this planning, I use a Retirement Income Dashboard to help my clients consolidate and streamline their retirement plans. The primary focus is to strategically build and optimise retirement income across the three phases of retirement: Go-Go years, Slow-Go years and No-Go years. The dashboard gives us a clearer overview of the expected retirement income and identify what income is coming in, when it starts, how much it may provide and where the gaps may still be.
From there, we can first identify whether there is still a gap in Phase 1 planning – reliable income for basic retirement needs. Once basic retirement income needs are sufficiently provided for, we can then assess whether there is still a gap in Phase 2 planning – growth income for inflation and lifestyle. You may discover that your existing investments already provide sufficient growth income. In that case, an indexed income solution may not be necessary. If there is still a Phase 2 planning gap, an indexed income solution may be one of the options worth considering.
The objective is not to simply buy another financial product. It is to first understand what you already have, identify the actual retirement income gap and then decide what solution (if any) is required.
So, Are Indexed Income Plans Suitable For You?
I think indexed income plans are worth understanding. For the right person, they may provide an interesting middle ground between growth and certainty. But I would not start by comparing which indexed income plan offers the highest projected return. I would first consolidate the retirement income sources you already have including your CPF LIFE income, existing annuities, investment income, potential rental income and other retirement assets.
Once everything is brought together, it becomes much easier to see whether there is an income gap. Only after understanding that gap should we assess whether an indexed income plan has a meaningful role in the retirement plan. Retirement planning is not about continuously adding more financial products. It is about making sure the different parts of your financial plan work together to provide the income you need throughout your retirement years.
The next step should begin with clarity on what you already have before deciding what else you need.
Article by Lee Meng
Email: meng.lee@gen.com.sg
The writer is an Executive Financial Services Consultant of GEN Financial Advisory
