The Fixed Indexed Annuities That Can Boost Retirement Outcomes

Fixed indexed annuities, or FIAs, are one of the most popular annuity types on the market today, with sales accounting for about 25% of all U.S. individual annuities sold in 2021.

Many of these FIAs are sold with a guaranteed lifetime withdrawal benefit, or GLWB, rider. The rider allows the purchaser to take withdrawals that are guaranteed for life, even if the account balance is $0. GLWB riders also offer flexibility: The owner maintains access to their account balance throughout their lifetime, which is not the case with income annuities (the most common of which is a single premium immediate annuity).

I investigated the efficacy of FIAs with a GLWB on consumer outcomes in a new study. I compared the projected performance of strategies involving a partial allocation to an FIA with a GLWB, against that of three other annuity-based strategies as well as a portfolio-only strategy. I analyzed projected retirement shortfalls and bequests for each strategy.

Overall, I found that FIAs with a GLWB improve projected retirement outcomes, but only if they are used properly. This typically entails buying the product before retirement and delaying withdrawals for about 10 years. To state the obvious, it also means that the purchaser has to stay in the contract throughout retirement. Owners of an FIA with a GLWB who exit their contract early are ultimately paying for a guarantee that they did not use to the full extent.

How Effectively Did Fixed Indexed Annuities With a GLWB Mitigate Portfolio Shortfalls?

We found that FIA-with-GLWB strategies provide more income than the portfolio-only strategy in cases where the retiree runs short of money. This is because an FIA with a GLWB is an insurance product that mitigates against market risk and longevity risk.

However, FIAs with a GLWB only boosted bequests compared with a portfolio-only strategy when we assumed the insurer did not increase the pricing spread or only increased it slightly. Elaborating on the latter, we ran cases wherein the pricing spread stays constant or increases in the projection. A pricing spread refers to the yield that the insurance company takes from the earned rate of the supporting portfolio for overhead costs and profit.

Smaller pricing spread increases may occur relatively often, as some insurers offer first-year teaser rates. Larger pricing spread increases are less likely as insurers may damage their reputations, crippling future business. Still, these scenarios should not be completely discounted, as the insurer ultimately controls what portion of the general account yield is used to buy options on the underlying index. Prospective purchasers could ask for historical index renewal rate data to see how the terms have changed over time.

Could Fixed Indexed Annuities With a GLWB Provide Richer Benefits Than Other Options?

FIAs with a GLWB with the most generous lifetime benefits tended to outperform other annuity-based strategies that I analyzed in terms of both bequests and mitigating shortfalls. Those interested in an FIA with a GLWB should compare products to find those offering the richest guarantees.

However, this finding is contingent upon the consumer buying the product before retirement (age 55 in the analysis) and waiting 10 years before starting withdrawals. If the consumer waits, the longer deferral period gives the benefit base time to grow, which substantially boosts the level of guaranteed income available.

Different retirees have different needs, of course. If a consumer needs income relatively soon, they may benefit more from a single premium immediate annuity, or a deferred income annuity. The other benefit of SPIAs and DIAs is that they are harder to misuse since they are irrevocable and do not require a decision to start withdrawals.

If a Consumer Is Likely to Lapse, an FIA With GLWB May Not Be the Right Choice for Them

I also examined consumer behavior as part of this analysis. A consumer’s likelihood of lapsing refers to the chance that they may voluntarily exit their contract. If they do lapse, this reduces or eliminates the effectiveness of FIA-with-GLWB strategies since the consumer has paid for a guarantee that they will end up not using throughout their full retirement.

When considering FIA-with-GLWB strategies, it is important to assess how likely it is for the owner to lapse or otherwise misuse the product. For example, consumers who are less knowledgeable about the product or who are less prepared for retirement may be more likely to lapse. Thorough education about product features and provisions is crucial if an FIA with a GLWB is the product of choice.

Conclusion

In sum, this research showed that a partial allocation to an FIA with a GLWB may help consumers achieve better outcomes. However, these products are not for everyone, as consumer mistakes can reduce or negate the benefits. They are also a very complicated type of product.

Prospective buyers may want to compare products, as FIAs with a GLWB are not all the same. Some products have significantly better benefits than others. It is also important to look at a historical index renewal rates before deciding on a product.

For a more detailed explanation of the topics discussed in this article, be sure to read the full report.