Like the all-electric automobile, the immediate variable annuity is a technology development that always lies just beyond the marketplace horizon. Ever popular with purists for its simplicity and growth potential, the so-called IVA is rarely seen on the street. Or, in this case, The Street.
Simplicity? IVAs work a lot like single premium immediate annuities (SPIAs). Both are life insurance in reverse: they reward people who live longer instead of those who die too soon. The owners get a guaranteed paycheck for life and/or a specific period.
Growth potential? Along with the income enhancement that mortality pooling provides, an IVA offers the upside opportunity of equities. Although clients must relinquish direct control of the premium, they can allocate their assets to equity mutual funds.
That's their beauty. Unlike straight SPIAs, whose payments are frozen, the monthly paycheck from an IVA can potentially match inflation. And unlike SPIAs, IVAs don't reek of rationing. They don't feel like a dead-stick landing into oblivion.
By letting people park their premiums in stock mutual funds (one contract even allows investors to move money around) an IVA lets retirees "stay in the game" and satisfies their hunger for hope and control. An advisor can even justify a fee for managing the assets.
IVAs aren't the easiest product to explain. At purchase, the owner has to choose an unchangeable "assumed interest rate," or AIR. The issuer uses this number, ranging from 3% to 6%, to calculate the initial payment and to determine whether subsequent payments should be more or less than the first one.
Instead of guaranteeing a dollar value, the initial premium buys a guaranteed number of units, like mutual fund shares. If the investments appreciate, so do the values of the units. If you set the AIR high, payments start higher but are less likely to grow and vice versa.
Compare the payouts of two AIRs, 3.5% and 5%. Vanguard's online annuity calculator shows that if a 65-year-old couple puts down $100,000 and chooses a 3.5% AIR, they can get a joint and survivor life (75% continuation) IVA with a 10-year period certain that pays $514.60 a month to start. If they select a 5% AIR, they'll start at $603 per month. In the long run, I'm told, the payouts will be identical.
IVAs are not to be confused with their popular cousins, deferred variable annuities with guaranteed lifetime withdrawal benefits (VA/GLWBs). Those are appealing because the client's assets stay liquid. But an IVA's annual payouts are generally richer: up to 8%, instead of 5%. That is, an IVA offers up to 40% more income for the same premium.
Who sells these strange hybrids? Fidelity's no-frills Freedom Lifetime IVA costs only 60 basis points a year and has a one-size-fits-all AIR of 3.5%. Clients can invest in target-date or target-risk portfolios. MetLife's Preference Plus Income Advantage IVA costs more (1.8% to 2.9%) but offers AIRs of 3%, 4%, 5% or 6%, and the flexibility to move money among 50 funds.
So, now that we've figured that out, can I interest you in an electric car?
Kerry Pechter is the author of "Annuities for Dummies" and editor of retirementincomejournal.com.