Income Annuities versus GLWBs: A Product Comparison
January 17, 2012
by Joe Tomlinson
Market rate comparison
Comparing these two products requires special adjustments to illustrate that VA/GLWBs only partially protect against inflation. I did the comparison by estimating VA/GLWB income increases and then constructing a matching income annuity. For the VA/GLWB, I used the Vanguard product discussed in Wade Pfau's article, which provides a 5% withdrawal guarantee for a 65-year-old. It has an annual fee of .95% for the GLWB rider and an average of .59% for other annuity and investment management fees, bringing the total to 1.54%. I developed an estimate based on Monte Carlo analysis that projected annual income increases of 1.28% for this particular fee level.
For the income annuity, I used market rates from Income Solutions®. (Vanguard is one of their partners, so I was able to compare two products offered through the same distribution system.) I used an annuity with a cash-refund feature, which guarantees that total payouts will at least equal the amount of funds invested in the annuity, thus matching as closely as possible the liquidity features offered by VA/GLWBs. I used a 50/50 blend of male and female rates because VA/GLWBs are not gender-specific.
At today's market prices, the initial payout rate for a cash-refund annuity, built to match the VA/GLWB's 1.28% income increases, is 5.51%. (This particular annuity, built to match the VA/GLWB income, falls between a traditional single-premium immediate annuity that provides level income, and an income annuity that fully adjusts for inflation.) With the payout rate of 5.51%, I could match the 5.0% payout rate for the GLWB and have some money left over to invest in a side fund.
For investments in both the VA/GLWB and the income annuity side fund, I assumed a 65/35 stock/bond mix, with stocks estimated to earn a nominal 7.5% and bonds a nominal 2% annually. The individual in this example was assumed to be 65 years old with 20 years remaining in his or her lifetime. I assumed this individual had $100,000 to invest and needed income of $5,000 per year with 1.28% annual increases.
Of course, the two approaches I describe above are not a retiree’s only options. Besides comparing results for the two products, I also estimated outcomes for a strategy of taking unguaranteed systematic withdrawals matching the annuity and VA/GLWB payouts. I used a 65/35 stock/bond portfolio with an investment expense ratio of .2% (i.e., assuming index funds).