Flexible Strategies for Longevity Protection: Comparing Two Products
April 10, 2012
by Joe Tomlinson
Products that guarantee income for life can be useful for retirement planning, but many clients also want flexibility and control over their investments. Two products that can meet these objectives are variable annuities with guaranteed lifetime withdrawal benefits (VA/GLWBs) and deferred income annuities (DIAs).
These products have been separately discussed in recent articles in Advisor Perspectives, and this article provides a side-by-side comparison. In December, Wade Pfau analyzed VA/GLWBs in GLWBs: Retiree Protection or Money Illusion?, and I looked at that product in Income Annuities versus GLWBs: A Product Comparison back in January. I also analyzed DIAs in New Tools to Manage Longevity Risk, which appeared last month.
The VA/GLWB is the more popular of the two products, and I'll illustrate its features with a simple example that I’ll carry through the rest of the article. Our exemplar is a 65-year-old female who has $500,000 for her retirement. She could invest the $500,000 in a VA/GLWB and, based on typical guarantees, begin taking a 5% ($25,000 per year) lifetime-withdrawal benefit starting immediately. The withdrawals would reduce the account balance in the VA, and, if the account were depleted (by long life or poor investment performance), the guarantee would kick in and payments would continue for life. Although she would be investing the full $500,000 in the VA, she would retain control of her money and would have the flexibility to invest in a mix of stock and bond funds.
Most VA/GLWB products also contain income "ratchets." If account values increase above the amount of the initial deposit (because investment gains more than offset withdrawals), the withdrawal guarantee would increase to 5% of this higher account value. Such increases are likely to fall short of providing full inflation protection, but they are an added benefit.
The DIA is a newer and less popular option, but it offers another way to provide guaranteed lifetime income. With this product, the individual in the example would pay about $45,000 to purchase a lifetime income stream of $25,000 annually that begins 20 years hence, at age 85. That would leave the remaining $455,000 available for systematic withdrawals over the 20-year deferral period. By contrast, it would cost approximately $400,000 to purchase a single-premium immediate annuity (SPIA) to provide the $25,000 income with no deferral, and the cost would lock up most of her retirement savings.