Lifetime income benefits were introduced as an optional feature on annuities over a decade ago. Today, roughly 75% of all retail variable annuities and 60% of all indexed annuities are purchased with a living benefit. By now, there must be millions of policyholders who have the ability to turn their annuity into a stream of income guaranteed for life without actually annuitizing the contract. Yet, relatively few have elected to do so … thus far. I believe that this is a mistake.
Given today’s low interest rates and ever-increasing life expectancies, activating the lifetime income benefit — even if a policyholder does not need the income — could provide attractive, low-risk rates of return. Alternatively, if a client in their late 70s or early 80s has not yet activated the benefit, you might explore dropping the rider in order to reduce the fees.
This article analyzes these options and provides next steps for you to approach your clients about maximizing the potential of their benefits. I use a racing analogy because the lifetime income benefit is a powerful vehicle — when handled right.
Prepare for the Race
Recently, one of our advisors called us for our advice on what to do with a variable annuity he sold to his client back in December of 2007. Given the timing of the purchase date, and the contract and living benefit fees, we were not surprised to see that the contract value had appreciated very little. By contrast, the income benefit base had compounded at 5% per year.
This particular 70-year-old client had an account value of $315,405 and an income benefit base of 525,045. (Note: for those of you who are wondering if the lack of a dollar sign in front of the income base is an editorial error, it is not. The income base has no monetary value, and therefore, in my opinion, has the potential of misleading clients when it is expressed with a “$” sign.)
The living benefit allows the client to take 5% of the income base, or $26,252, per year. But the proper way to think of this situation is not in terms of the income base, but rather as a percentage of the account value. The allowable lifetime withdrawal amount of $26,252 is 8.32% of the account value. If a 70-year-old client walked into your office and said he wanted to withdraw 8.32% of his portfolio every year, would you give the plan a thumbs-up, or would you advise against it?
Unless you had a reason to believe his particular life expectancy was below the average of 14.1 years for a male his age, my guess is that you would advise against it for fear that a market downturn combined with the withdrawals would cause the client to run out of money before he died. The lifetime benefit eliminates this issue, but only if it’s turned on.
This case is far from unique. We regularly see policies that could generate in excess of 7% of the account value in lifetime income. Amazingly, we came across a policy that allowed a 66-year-old to withdraw almost 9.5% of the account value. Consequent to the last market crash, variable annuities issued between 2004 and 2008 are the most likely candidates, but even policies issued as recently as 2011 could provide surprisingly high lifetime income payout rates. Many of those policies required policyholders to use a volatility managed investment option. Most of these strategies have indeed protected the downside, but in exchange for capturing very little of the upside, thereby allowing the income base to grow well beyond the account value.
Start Your Engines