For a while now, guaranteed income has been a defining factor in the annuity market. A report released in December by the Government Accountability Office found that these popular benefits aren't without risk, though.
The report examined variable annuities with guaranteed lifetime withdrawal benefits (VA/GLWB) and contingent deferred annuities (CDA), as well as the regulations that cover each.
A CDA gives an investor guaranteed lifetime income payments if his or her investment account is exhausted, the report said. Unlike an annuity, the assets in the CDA are typically held in a brokerage or investment advisory account, rather than by the insurer. Payment is contingent on the assets falling to zero, according to the report. Of the products reviewed by the report, fees on CDAs were based on a set percentage of the assets per year, and didn't include fees paid for the underlying assets that the CDAs cover.
There are some other structural differences between CDAs and the variable annuities to which guaranteed benefits are attached. With an annuity, investors can annuitize an account balance in the future, something they can't do with CDAs. Investors would have to sell the assets covered by the CDA and use the proceeds to purchase a separate annuity.
Furthermore, investors can elect death benefits with a variable annuity, a feature not available with CDAs.
VA/GLWBs and CDAs both have three phases, according to the report: the accumulation phase, withdrawal phase and insured phase. When investors withdraw all the assets they accumulate, they reach the insured phase, when the guaranteed benefit kicks in. With both products, once the insured phase begins, investors generally can't change the schedule or amount they've established, according to the report.
VA/GLWBs and CDAs both offer investors the ability to withdraw assets at any time, according to the report, but with CDAs, investors can apply guarantees to assets they already own, such as in an IRA, instead of selling the assets and purchasing a new annuity.
The report stressed that both products are complex and not suited for every investor. Those who purchase a CDA or VA/GLWB without understanding or guidance from a professional run the risk of investing an inappropriate amount. "Insurers with whom we spoke said that VA/GLWBs and CDAs are generally attractive to middle-income consumers who want more control and flexibility over the investments they are relying on to provide retirement income," the report stated. Another insurer consulted for the report said investors with approximately $500,000 in retirement assets invested about 20% of that in variable annuities or CDAs.
