RILAs: Supporting client goals in retirement

This is the year of “peak 65,” with a record 4.1 million Americans poised to turn 65 in 2024 and every year through 2027. As Americans in this record surge hit retirement age, they and their advisors must navigate four core risks that will impact their retirement portfolios through the decumulation phase: longevity, inflation, volatility and emotions.

A new study shows that using structured annuities with income benefits on the portfolio’s efficient frontier substantially increases the likelihood that clients will have assets left at age 100. 

Wade A. Pfau, professor at The American College, along with Equitable, conducted research on how to improve the efficient frontier, enhance risk-adjusted returns and help advisors — and their clients — make the most of assets through their retirement. The research found that replacing part of the bond allocation in the retirement portfolio with each of the eight different structures of a registered index-linked annuity and including a living benefit can contribute to meeting a client’s retirement spending goals, while preserving assets for a legacy.

The results of the research are published in the paper “Supporting client goals in retirement: The role of structured annuities with living benefits.”

Investment managers have tended to view risk pooling as unnecessary because the stock market can be expected to perform well over time, the research report said. However, once distributions begin, any downward volatility in the early years of retirement can disproportionately hurt a retirement spending plan’s sustainability. Longevity risk means retirees do not know just how long their assets will need to last. Investment managers may not fully appreciate the impact of these risks. 

Today, the value provided by risk pooling is becoming better understood as retirement income planning has emerged as a distinct field within financial services. This is happening as traditional sources of risk pooling, such as company pensions and Social Security, play a reduced role and retirees look for ways to transform their 401(k) savings into sustainable lifetime spending.

Traditional stock and bond investments offer a distribution of future investment outcomes that follows a bell curve and may not provide the best potential trade-offs between risk and return, the research found. Financial products that use options to create structured returns offer the potential to produce a more attractive range of investment returns and can be treated as asset classes available for the asset allocation decision. This can also help with achieving annual resets during the distribution phase and avoid the depletion of annuity asset values.

The protected lifetime income covered by the asset base used within a variable annuity with structured return segments helps reduce pressure for distributions from the unprotected part of the asset base. More of the spending early on comes from the annuity and less is from the rest of the unprotected investments. The risk pooling from the annuity helps support a disproportionate portion of the spending, which lays a foundation for other investment assets to grow. The structured returns provide an opportunity for annual resets to increase protected spending and provide more potential to prolong the account values of annuities during retirement. This reduces sequence risk for the unprotected assets and increases their sustainability when used as part of an overall retirement income strategy. 

Using a guaranteed lifetime withdrawal benefit with a portion of retirement assets can help clients raise success rates, meet more of their lifetime spending goals and even have a positive impact on legacy values. This analysis demonstrated the potential value of a variable annuity to layer in insurance for meeting retirement spending goals.

The research also compared these findings with other annuity approaches, such as traditional variable annuities that allocate to investment subaccounts, and fixed indexed annuities. Compared to traditional variable annuities with living benefits, the structured segment approach explored in the research allows for lower fees and competitive performance. Compared to fixed indexed annuities, these structured segments provide a stronger chance that assets will remain over time and that the guaranteed income will grow. 

Pfau said his research saw that a RILA with dual direction segments “is an interesting structure that competes very well against bonds and actually contributes a lot to a retirement plan in terms of those metrics that we’re looking at, such as meeting spending needs and preserving assets for legacy.”

Dual direction segments provide 100% participation in market gains up to the cap, but they offer a different exposure to downside risk. The owner remains exposed to any losses beyond the segment buffer. But instead of being credited with 0% when a negative price return occurs at a value less extreme than the buffer, this segment provides a positive price return at the opposite value of the index loss. 

For example, if the price return is -5%, then the annuity credits a 5% return, and if the price return is -9%, then the annuity offers a 9% price return. This annuity offers segment buffers of 10% and 15%. Since it provides gains for small market losses, less upside potential should be expected with positive market performance. 

In this case, the cap with a 10% segment buffer is 15% (instead of 18% with the standard segment), and the cap with a 15% segment buffer is 11% (instead of 15% with the standard segment). The graphic above illustrates how the structured returns for these dual direction segments are determined relative to the underlying index price return.

What advisors need to tell clients

How does an advisor guide their clients to the right guaranteed income solution?

“When you help clients transition from accumulating assets to drawing them down, you need to deal with a lot of the different things that clients also deal with as they go to the place where they pull money out of their portfolio,” said Pete Golden, managing director, individual retirement at Equitable.

“We see these guaranteed lifetime income products being positioned by individuals who are five years out from retirement or as they’re hitting that retirement zone, where they want a guaranteed income in retirement that complements Social Security, pensions or whatever forms of retirement income they have. A product like RILAs can provide another source of income for an individual.”

Golden said RILAs with income guarantees provide clients with buffered investment options and market upside.

“For advisors, the appeal of RILAs is for clients who want to stay invested in the market but also want to have guaranteed income so they have a consistent, reliable income in retirement. We see a lot of advisors looking at RILAs with income strategy to help clients achieve their goals.”

Susan Rupe is managing editor for InsuranceNewsNet. She formerly served as communications director for an insurance agents' association and was an award-winning newspaper reporter and editor. Contact her at [email protected].