Operating without a net

The benefits and risks of adding a lifetime income rider to a variable annuity

Operating without a net

What is probably the most difficult set of decisions faced by any financial advisor? Wading through the countless financial products available and selecting what is best for a client. Variable annuities (VAs) are a popular choice for those desiring an income-focused investment approach, and there are a variety of riders that can be used to tailor benefits to a client’s unique needs. Let’s examine the lifetime income rider,1 and how accepting or declining this feature may affect asset allocation considerations within a portfolio.

First, a brief refresher — a variable annuity is a long-term, tax-deferred investment contract usually written by an insurance company. In return for an up-front payment(s), the contract is designed to provide investors with a way to accumulate funds and then distribute those funds as income later on — typically during retirement.

The lifetime income rider

What is it? While a basic variable annuity is designed to provide the holder with a future income stream, there is no “floor” — the payments are based solely on the performance of the contract’s underlying securities. For an added fee, a lifetime income rider can be added to the contract. This provides a level of assurance for investors who don’t feel comfortable with full exposure to market risks. A VA with this option retains two valuable benefits — tax-deferral on interest and capital appreciation along with tax-free exchanges between sub-accounts. Adding this rider is like a trapeze artist operating with the safety of a net below. If the portfolio performs poorly, the insurance company is obligated to honor the terms of the rider, effectively guaranteeing some minimum return.

How does it work? For an annuity with a lifetime income benefit rider, the advisor and investor have numbers to consider — the account value and the benefit base. The account value is exactly what it sounds like — the total value of the investments within the annuity, priced daily. The benefit base is the calculated value from which the guaranteed income will be derived and paid to the client for life. Most insurers guarantee a minimum rate of return within that benefit base, or allow the client to “lock in” the higher of the account value or benefit base.

Portfolio construction considerations. By adding a lifetime income rider, the advisor can invest more aggressively on behalf of a client because a level of portfolio risk has been transferred to the insurance company. And, because benefits will be calculated on whichever number is higher — the account value or the benefit base — it may be advantageous to build a more aggressive portfolio in pursuit of a higher account value. By writing the contract, the insurer has agreed to shoulder any financial burden resulting from unfriendly market conditions. Investors can think of this as insurance on their insurance.

Back to (portfolio) basics

What happens if this “safety net” is not wanted by the client? Without the lifetime income benefit rider, a variable annuity is known as an investment-only variable annuity (IOVA). For these accounts, it is up to the advisor and client to agree on the components of a portfolio where the asset classes, risks and return expectations are understood. After all, both the client and the advisor need to sleep well at night. With no benefit base to fall back on under this scenario, it is the account value on the client statement that determines the amount of future payments. Volatility, standard deviation and the possibility of loss are now critical considerations.

Building a better IOVA portfolio

So how can financial advisors build better portfolios for clients within an IOVA? It’s time to go back to basics and build the portfolio as if it were not an annuity at all. Build it like a traditional investment portfolio where volatility and loss are to be avoided, or at least minimized, and projected returns are commensurate with risk.

For additional information on variable annuities and how contract options like lifetime income riders may help investors meet their financial goals, please contact your financial advisor.

Important information

Blog header image: idiz/Shutterstock.com

An investment-only variable annuity is a variable annuity without living benefits (without a lifetime income rider). The amount of future payments is solely dependent on investment performance net of fees.

A lifetime income rider (also known as a guaranteed lifetime withdrawal benefit) is an optional benefit (available for additional cost) that guarantees the contract holder can withdraw a specified percentage of a guaranteed benefit base annually for the duration of the contract holder’s life, regardless of account performance.

Sub-accounts are the separate investment accounts into which the variable annuity premiums are placed. These accounts allow contract holders to allocate money across the investment options available on the variable annuity platform.

All contract and rider guarantees, including optional benefits and any fixed subaccount crediting rates or annuity payout rates, are backed by the claims-paying ability of the issuing insurance company. They are not backed by the broker/dealer from which this annuity is purchased, by the insurance company from which this annuity is purchased or any affiliates of these entities, and none makes any representations or guarantees regarding the claims-paying ability of the issuing insurance company.  Guarantees do not apply to the investment performance or safety of amounts held in the accounts of variable annuities.

Standard deviation measures a portfolio’s or index’s range of total returns in comparison to the mean.

Correlation is the degree to which two investments have historically moved in relation to each other.

Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations over time.

Annuities contain additional risks and charges, as well as other factors that should be taken into consideration. Investors should review all financial material before investing. Invesco Distributors, Inc. does not offer annuities.

All contract and rider guarantees, including optional benefits and any fixed subaccount crediting rates or annuity payout rates, are backed by the claims-paying ability of the issuing insurance company. They are not backed by the broker/dealer from which this annuity is purchased, by the insurance company from which this annuity is purchased or any affiliates of these entities, and none makes any representations or guarantees regarding the claims-paying ability of the issuing insurance company.

Annuities contain additional risks and charges, as well as other factors that should be taken into consideration. Investors should review all financial material before investing. Invesco Distributors, Inc. does not offer annuities.

Jeff Hughes, CAS
National Sales Manager

Jeff Hughes is National Sales Manager for the Insurance and Education Sales Division of Invesco. Mr. Hughes oversees sales activities for the variable annuity and 529 businesses in the United States. Prior to assuming his current position, Mr. Hughes was a senior regional vice president for Invesco covering the northeastern United States.

Before joining Invesco in 2001, Mr. Hughes was a vice president and portfolio representative, specializing in annuities and the insurance industry for PIMCO Advisory Services. Prior to joining PIMCO Advisory Services, he was a regional wholesaler with Alliance Capital, a money management firm based in New York City. Early in his career, Mr. Hughes worked as a financial consultant at NatWest.

Mr. Hughes earned a BS degree in finance from Virginia Tech. He holds the Series 7, 24, 63, 66 and 79 registrations, as well as a Certified Annuity Specialist (CAS) designation from the Institute of Business and Finance.

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