Flexible Income Options No Longer ‘One Size Fits All’
January 28, 2010 by Del Campbell and Kris Kattman
People are not looking just for annuity solutions but income solutions that provide opportunities for long-term growth along with protection from market downturns.
In the past, pension plans combined with Social Security and personal savings to form a retirement asset foundation for lifetime income. The new reality is that the amount of future Social Security benefits is uncertain and pensions are no longer the norm; so managing the risks of longevity, market volatility and inflation now pose a significant burden for individuals.
However, sound financial planning and flexible income annuity solutions that provide guarantees and lifetime income benefits are ways to ensure retirees do not outlive their income.
What’s on the horizon? Many successful insurers will look to provide clients with both variable annuity and fixed annuity solutions. These solutions may seek to appeal to clients who want the stability of a fixed income annuity but the growth potential of a variable option. To do this, they may innovate for solutions that include both fixed and variable lifetime income options.
Living income benefits. Currently, there are only a few true income products. The need is for better income solutions, both fixed and variable, that provide living benefits and guarantees.
Providers that offer lifetime withdrawals on VA guaranteed minimum withdrawal benefits (GMWB) have been leading the pack by providing a guaranteed income stream that doesn’t require clients to give up asset control. These solutions offer clients equity exposure to provide growth potential, while providing an effective hedge against inflation. Clients retain control and access to assets once income is drawn, and the guaranteed lifetime income stream mitigates longevity risk.
GMWBs do have drawbacks. As with any type of VA feature, clients need to consider the fees. Also, all distributions are taxed gain first. In addition, the products pose sequencing risk; that is, while they can offer an effective hedge against inflation over the long term, individual years may not match up at all. For example, the markets were down 40% in 2008 but inflation showed a modest increase.
More customized income features provide income guarantees, but also provide for better income potential by setting a floor guarantee while also providing for higher initial and potential income growth. This benefit can be even more important in today’s retirement accounts that may be down significantly due to the market.
By maximizing income potential, clients may have a better chance of meeting their income needs from individual retirement accounts. Additionally, in non-qualified accounts, this type of annuity solution can have significant tax advantages while keeping the control, access and flexibility typically associated with VAs. Clients benefit from tax-free return of cost basis until they receive the original cost basis back. (Taxes may be due upon distribution.)
Inflation-protected annuities: Many new inflation-protected annuities are helping address previous client objections to traditional single premium immediate annuities by re-engineering the traditional product chassis.
One potential challenge with such annuities is that initial payments will be lower as assets increase in value with inflation over time.
But immediate inflation annuities are gaining in popularity, because they offer guaranteed income, inflation adjustments to income payments, and freedom for clients to manage their own income. The products also permit access to money in case of an emergency. This type of annuity often includes a death benefit too, with a rate of return exactly equal to the rate of inflation at the time of death.
Rethinking fund strategies. Insurance companies are including passively managed funds, in addition to actively managed funds, in their VAs. Some insurers have also added exchange-traded funds to their VA menus. This increases flexibility and choice for clients.
Today’s reality is that the market needs a breadth of retirement solutions and, most importantly, flexible options. Such income annuity solutions will allow clients to have asset control and income payments for life that can be guaranteed at a minimum income level, regardless of fluctuating market conditions.
Del Campbell is assistant vice president-variable annuity products, and Kris Kattmann vice president and associate actuary, for Lincoln Financial Group’s Retirement Solutions business. Campbell is based in Ft. Wayne, Ind., and Kattmann in Greensboro, N.C. The authors may be reached at email@example.com.