How to Choose the Best Lifetime Income Options for Clients
Annuities can reduce the risk of running out of money in retirement, but they protect against this risk in different ways. I’ll compare retirement outcomes for single-premium immediate annuities (SPIAs) to guaranteed lifetime withdrawal benefits (GLWBs) to understand the key product differences.
As background income annuities provide a lifetime income in exchange for an up-front premium and may be either SPIAs or deferred income annuities (DIAs). Another approach to providing lifetime income is GLWBs offered as an optional rider to variable annuities (VAs) and fixed index annuities (FIAs). These riders allow withdrawals to continue for life even if annuity account values are depleted.
Income annuities are the simplest product – you pay a fix sum up front and receive a predetermined payment per month for life. With SPIAs, income payments begin immediately, while with DIAs, the commencement of income is delayed. For example, a 65-year-old might purchase a DIA with payments commencing at 85 in order to provide longevity protection or funds for long-term care. The government even sanctions this type of DIA for tax-deferred accounts as a qualified longevity annuity contract (QLAC) so that required minimum distributions (RMDs) can be delayed. SPIAs and DIAs can be structured with either level payments or payments that step-up by a given percentage each year. A few companies formerly offered SPIAs where payments increased each year based on actual inflation – an ideal add-on to Social Security – but this product is no longer offered due to lack of demand.
VAs and FIAs with GLWBs
While income annuities have been available in various forms for thousands of years, GLWBs only have a 20-year history. First they were offered as an optional rider on VAs and then later on FIAs as FIAs became more popular. With GLWBs, there is a maximum allowable initial withdrawal percentage that increases with age – 5% of the VA or FIA account value at age 65 is typical. A shadow account, or benefit base, is set up when the first withdrawal is taken and this benefit base will never decrease, but can increase (ratchet-up) if the account value grows to be greater than the benefit base. The allowable withdrawal percentage, set at the initial withdrawal, is applied to the benefit base. Hence, allowable withdrawals can increase, but never decrease below the initial allowable level. The allowable withdrawal level then continues for life, even if the underlying account value is depleted. With GLWBs, the annuity owner can surrender the contract, giving up withdrawals guarantees, and thus have access to the full remaining account value. For SPIAs and DIAs there is no account value, although some offer an option for payments for early deaths.
The chart below, provided by the LIMRA Secure Retirement Institute, shows a 10-year sales history from 2009-2018 for VAs, FIAs, and income annuities, plus more recent history for both VA and FIA sales where a GLWB rider was purchased.