It turns out the retirement industry was indeed onto something when it started adding a guaranteed minimum withdrawal benefit (GMWB) rider to variable annuities a couple years ago. A new report by Ibbotson Associates has found that adding a variable annuity with a lifetime GMWB rider to a traditional stock and bond retirement portfolio can increase income while decreasing income risk.
Total assets under management for variable annuity accounts at the end of 2006 reached $1.36 trillion, an increase of 38.2% since the end of 2001, Ibbotson says–with GMWB being the dominant sales driver for variable annuities in recent years.
The Ibbotson research report, titled Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit, examined two types of income risk–both the risk of a portfolio's income stream declining from one year to the next and the risk of a shortfall. According to Ibbotson, a GMWB rider for life gives investors the ability to withdraw a fixed percentage (for example, 5%) of the benefit base each year until death. "The benefit base can rise annually when the market has performed well, but will not fall," the study found. "So investors are protected against any nominal investment losses in a down market without losing the benefit of upside gain in a strong market," the study says. In exchange for this benefit, the study says, "the investor pays a fee each year, and the remaining contract value at death is paid to beneficiaries."
To test the costs and benefits of adding the VA and GMWB riders to traditional retirement income portfolios, the study's authors performed a series of simulation analyses across three investment scenarios: a diversified asset allocation variable annuity with GMWB; a diversified traditional non-annuity portfolio, such as mutual funds; and a combination of a variable annuity with a GMWB and traditional non-annuity product.
Here's what the study results showed. "Empirical results using historical returns and Monte Carlo simulations showed that the combined portfolios had higher average total income return and total income withdrawals as well as lower negative income return over a 30-year retirement period," the authors found. "These results make sense intuitively," the study says, "because a variable annuity with a GMWB has no income risk–the income benefit base will not decrease, even if the market goes down." They continued: "This guaranteed income protection allows the investor to allocate assets to a more aggressive variable annuity, leaving the overall portfolio with a higher equity allocation. More equity contributes to an increase in total income while the guaranteed income from the withdrawal benefit rider helps lower the overall income risk for the combined portfolio."
