Though the problems plaguing the variable annuity market have been widely publicized in recent years, for many clients, the appeal of pairing market participation with the guaranteed lifetime income that can be purchased in rider form remains unscathed.
Unfortunately, many clients fail to engage in the cost-benefit analysis that can help predict whether the cost of the guaranteed income rider is worth the benefit that it can provide. Often, clients who do carefully analyze the potential return on guaranteed income riders are finding that in today’s market, the costs simply exceed the benefits.
Luckily, a strategy has emerged to allow clients to reap the benefits of both market participation and income guarantees should the markets underperform by using a combination of variable and deferred income annuities to more accurately reflect the reality of today’s annuity investment landscape.
The Problems With Guaranteed Income Riders
In the minds of many clients, pairing a variable annuity with a guaranteed income rider can neutralize the risks associated with variable annuity investing because the rider will provide a guaranteed level of income in the event that the variable annuity itself underperforms.
However, these clients often fail to consider the costs associated with guaranteed income riders—rather than paying for the entire value of the rider up front, the cost is generally assessed on a periodic basis over the life of the rider. In other words, the longer the client lives and collects guaranteed income benefits under the rider, the higher the cost of the rider itself.
In the past, it may have been possible to offset these costs by allocating variable annuity funds to riskier—and potentially more lucrative—investments so that the income rider could more accurately be characterized as a fallback option. Modern-day variable annuities, however, often require the client to diversify investments among more conservative options in order to limit the risk exposure of the insurance company that issued the contract.
Further, many companies have sought to modify the terms of older annuity products to require that investments be allocated more conservatively. The end result is that the client’s upside potential on the variable portion of the annuity is limited while the cost of purchasing the income guarantee is rising.
The New Variable-Deferred Annuity Strategy
The problems associated with guaranteed income riders today have many variable annuity contract purchasers searching for innovative ways to ensure a guaranteed income level even if their variable contract underperforms in a market downturn. Fortunately, the increasing availability of deferred income annuities has presented a solution.
Adopting the variable-deferred income annuity strategy allows the client to bypass the guaranteed income rider altogether. The client simply purchases a variable annuity and a second deferred income annuity that will begin payouts around the time when the variable annuity funds could be depleted.
Importantly, because the premium for the deferred income annuity is paid up front, this strategy allows the client to guarantee a set level of income late in life while removing the cost variances that have proven problematic if a guaranteed income rider is used instead.
Further, unlike some income riders, because the deferred income annuity is purchased separately from the variable product, it is in no way dependent upon the client’s decision to annuitize the variable annuity, and it will begin payments regardless of whether the variable account is actually depleted.
The changing variable annuity landscape is keeping advisors on their toes when it comes to developing new strategies for annuity purchasers, and combining a variable product with a deferred income annuity is one example of how the benefits that could be reaped in the past can be replicated based on modern conditions.
Originally published on National Underwriter Advanced Markets. National Underwriter Advanced Markets is the premier resource for financial planners, wealth managers, and advanced markets professionals who provide clients with expert financial and retirement planning advice.
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