When a VA with lifetime income benefits offers the greatest value

The number of annuity offerings available in the marketplace continues to expand, but sometimes it’s a good idea to take another look at a product that’s a bit more traditional: a variable annuity with lifetime income benefit riders.

A new white paper identifies when a VA with lifetime income benefits can offer the greatest relative value to a retiree. Wade Pfau, professor of practice at The American College, wrote the paper for Equitable. It is the third in a series of research papers Pfau wrote for Equitable.

“We wanted to look at the traditional VA with living benefits as it's probably something that advisors were more familiar with,” Pfau told InsuranceNewsNet. “We wanted to look at a broader range of scenarios to see if we can be more informed about different characteristics of individuals, where, on a relative basis, the annuity might perform better than in other scenarios.”

Retirees and preretirees may fear the impact of market volatility on their retirement portfolio, but Pfau said the VA’s living benefit “is a put option on the stock market.”

“If the market's down, your spending is still protected; even if the account balance hits zero, you have that protected lifetime income. We have evidence that people are better able to stay the course in the face of market volatility when they have that income protection in place.”

Pfau’s research considered a variety of issue ages, retirement starting ages, asset allocation with and without the annuity, and overall retirement spending goals as a percentage of retirement assets. He concluded that a VA may provide a greater relative value, first, for retirement starting at ages between 60 and 70 when income begins immediately.

Those who begin retirement between the ages of 60 and 75 can see strong relative performance when the VA has a 10-year deferral period before income begins. In this scenario, a VA issued to a client as young as 50 can make sense for those planning to retire in the 60 to 75 age range.

Pfau’s research also found a compelling case can be made for using annuities when the owner feels more comfortable with taking market risk after the protections are in place. Because lifestyle is less at risk from a market downturn, retirees with annuities may have greater risk capacity to invest more aggressively, he wrote. Doing so can provide greater exposure to the risk premium of the stock market, which tends to improve retirement outcomes. Greater relative value can be provided when using annuities with a more aggressive asset allocation than one would otherwise choose with an investments-only strategy that lacks insurance protections.

A strong case can also be made for a partial annuity strategy regardless of the funded level for retirement, the research found. Conventional wisdom suggests that overfunded retirees may not need annuities because they are at low risk of depleting investment assets, Pfau said. While it is true that such retirees are less likely to run out of money, it is also true that including risk pooling for a portion of assets may allow a disproportionate amount of spending to be generated by the annuity assets, which can lead to less distribution pressures on non-annuity assets. This may provide a greater opportunity for the non-annuity assets to grow and support larger retirement legacies.

On the other hand, for underfunded retirements requiring high distribution rates, retirement success is at greater risk. The value of risk pooling in these cases is that the annuity assets will generate a lifetime income stream that continues to support part of the spending needs after unprotected investments are depleted.

Takeaways on VAs for advisors

Pfau offered some takeaways from the research for advisors who want to present VAs to clients.

“I think the first thing the advisor would want to talk about is how things change after you retire – that when you're no longer living off your paycheck, you now have to live off your assets, and this is really the whole introduction to retirement,” he said.

Retirement income is different from preretirement wealth management, Pfau added.

“In retirement, you have to meet expenses over an unknown time horizon. That’s where you can self-manage that risk. If you just extrapolate the preretirement investing world into post-retirement, you’re self-managing this risk. Instead of adding new savings, you’re taking distributions from your investments but you also are going to try to manage those investments over an unknown retirement horizon. Annuities provide a way to pool that risk so that you don’t have to self-manage it.”

Annuities support a higher level of spending in retirement, he said.

“So when you have a client thinking about retirement, if they can start thinking about positioning some of their traditional bonds into protected income sources that offer a risk pooling component, it can be a much more efficient way to meet their retirement goals.”

Pete Golden, managing director, individual retirement at Equitable, cited surveys that revealed more than half of retirees say their biggest fear is outliving their assets during retirement.

“As an advisor, you want to guide clients through retirement, and if this is one of their bigger fears, you want to make sure you address that fear and provide some form of guaranteed income for life,” he said.

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Susan Rupe is editor in chief, magazine, 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 susan.rupe@innfeedback.com.