The insurance marketplace continues to expand its annuity offerings, but a recent white paper suggests it’s worthwhile to revisit traditional variable annuities (VAs) with lifetime income benefit riders. Wade Pfau, professor of practice at The American College, authored the paper for Equitable, examining when these financial products provide the greatest relative value to retirees.
Pfau’s research, the third in a series of papers for Equitable, focused on traditional VAs with living benefits, a product that advisors are likely familiar with. The study aimed to assess various scenarios to better understand individual characteristics that might make VAs more suitable. According to Pfau, the VA’s living benefit “is a put option on the stock market,” protecting spending even if the account balance reaches zero.
Key Findings for Retirees and Preretirees
The research considered multiple factors, including issue ages, retirement starting ages, asset allocation with and without the annuity, and retirement spending goals as a percentage of retirement assets. Key findings include:
- VAs may offer greater relative value for those retiring between ages 60 and 70 when income begins immediately.
- For those beginning retirement between 60 and 75, VAs with a 10-year deferral period before income starts can perform well. In this scenario, purchasing a VA as young as 50 can be beneficial for those planning to retire in their 60s or early 70s.
Annuities and Investment Strategy
Pfau’s research also found that annuities can enable retirees to take on more market risk, as their lifestyle is less vulnerable to market downturns. This increased risk capacity can lead to greater exposure to the stock market’s risk premium, potentially improving retirement outcomes. The study suggests that using annuities with a more aggressive asset allocation can provide greater relative value compared to an investments-only strategy lacking insurance protections.
Implications for Advisors and Clients
The research supports considering a partial annuity strategy regardless of retirement funding levels. For overfunded retirees, including risk pooling for a portion of assets can generate a disproportionate amount of spending from annuity assets, reducing distribution pressures on other assets and potentially allowing them to grow. For underfunded retirements, the annuity’s lifetime income stream can continue to support spending needs after other investments are depleted.
Pfau emphasized that retirement income planning differs significantly from preretirement wealth management. In retirement, individuals must meet expenses over an unknown time horizon, making risk management crucial. Annuities provide a way to pool this risk, supporting a higher level of spending in retirement. By positioning some traditional bonds into protected income sources with a risk pooling component, retirees can more efficiently meet their retirement goals.
Pete Golden, managing director of individual retirement at Equitable, noted that surveys show more than half of retirees fear outliving their assets. Advisors can address this concern by providing guaranteed income for life through annuities, helping guide clients through retirement with greater financial security.
