Variable annuities with guaranteed-minimum-withdrawal benefits allow investors to reduce risk and increase retirement income, according to a recent study.
Paired with mutual funds in a portfolio, a VA can create a higher income level over a 28-year period than other investments, while decreasing the risk that the income payments will be reduced, according to the study from Ibbotson Associates Inc. and funded by Nationwide Financial Services Inc. of Columbus, Ohio. It noted that because the investment allocation within an annuity can be more aggressive, investors may accumulate more money in their accounts and generate more income.
"Variable annuities in this context aren't for accumulating wealth but for creating income," said Peng Chen, president and chief investment officer of Ibbotson Associates in Chicago.
The study, which also addressed market and longevity risks, used three scenarios beginning in 1979: A diversified asset-allocation variable annuity account with a withdrawal benefit, a traditional diversified portfolio and a combination of the two. In the last scenario, a portion of the fixed-income and cash allocation was replaced with a VA.
In a $1 million "moderate conservative" portfolio with an allocation of 40% in equity and 60% in fixed income, the addition of a VA made the portfolio slightly more aggressive by shifting its allocation to 47% equities, 53% fixed income.
The VA addition also boosted income — from $2.89 million, which a 40/60 allocation generated, to $3.15 million, which came from a portfolio with 40% in equities, 45% in bonds and 15% in a VA. The time period was 1979 to 2006.
The principal value of the portfolio with the variable annuity also was greater, reaching $2.52 million, compared with $2.35 million for the traditional 40/60 portfolio. Income from both the VA and non-VA portions of the portfolio remained steady at 5%.
PROTECTION
Once an investor reaches retirement age, he or she is more concerned with protecting income than accumulating money, said Eric Henderson, senior vice president of individual investments at Nationwide Financial.
"In a typical portfolio, you lose if the market underperforms," he said. "Longevity risk couldn't be managed before, but even if the portfolio balance falls, you'll still get income."
Some advisers are already using a similar method and reported that their clients are asking about it. In the case of David Lesnick of Sound Advice Financial Planning in Goodyear, Ariz., one client invested around $200,000 in July, and his portfolio reached a high of $231,000.
The client's VA contract, which was offered through American Skandia Life Assurance Corp. of Shelton, Conn., locked the value of the portfolio at that high point and used $231,000 as an income base.
The downside of this strategy is that the client needs to keep his or her hands off the investment and let the money do its work. "If [the client] wanted to cash out now, the portfolio value would be about $214,000," Mr. Lesnick said. "But if he wanted to take income on it, he would be drawing from about $231,000."
Advisers familiar with the strategy said the timing of the annuity purchase and the timing of when the investment becomes more aggressive could affect the payout.
"If the client is still young, it's fine. But within the proximity of retirement, there's some risk to the client as far as being able to cover all of the expenses," said Joanne D. Mungall, who has been a certified financial planner at Wealth Management Associates in Foster City, Calif., for nearly seven years.
If the underlying investments in the annuity are too aggressive, performance could be poor and the guaranteed-withdrawal benefits might lag the inflation rate, she said.
RISK-AVERSE
On the other hand, if the annuity is moderately aggressive, the guarantees encourage risk-averse clients to own equities and maintain peace of mind.
"There is a psychological factor when you have an ultraconservative client and their allocation is something like 25% equities and 75% fixed income," Ms. Mungall said. "Investing more aggressively for that individual's risk profile makes sense."
Although the strategy doesn't work best for all investors, the analysis at least encourages advisers to consider the option, Mr. Henderson said.
"This strategy acts as insurance protecting retirement dollars to provide a sufficient, stable income," he added.
"There are customers who invest appropriately, and there are those who are very conservative," Mr. Henderson noted. "This permits people to get comfortable with investing."
Darla Mercado can be reached at [email protected].
