Wade Pfau Speaks Out on Retirement Product Some Advisors Love to Hate

The Variable Annuity Fit

An effective risk-wrap strategy combines investment growth opportunities with lifetime spending protections, which is the domain of variable annuities offering lifetime income benefits, Pfau says.

Variable annuities with living benefits are designed to offer upside growth potential with secured lifetime spending even if markets perform poorly.

"Such tools also maintain liquidity for the underlying assets, as deferred annuity assets remain on the balance sheet and can be invested with their values shown on portfolio statements," he explains. "There is commitment and back-loaded protection, but these strategies can also be reversed with remaining assets returned to those who decide they no longer want or need the lifetime spending protection."

The secured retirement income guardrail through the variable annuity's lifetime income benefit addresses the willingness to commit and the longevity-risk aversion dimensions that risk wrap investors want, says Pfau.

"With a nationally representative survey, we find that about 15% of the population between ages 50 to 80 have the characteristics that resonate best with considering tools such as deferred variable annuities," he adds.

Evaluating Variable Annuities for Clients

The article provides clear explanations of variable annuities' key features, including:

• Guarantees' growth during the deferral period
• How guaranteed withdrawals are determined and how they can grow during the distribution period
• Variable annuities' death benefits
• How insurers manage contract guarantees' risk
• A method to help consumers evaluate variable annuities with different downside protections and upside exposures

Pfau suggests retirement advisors initially consider a variable annuity's income features instead of getting buried in the products' technical details. "It is important to first focus on the amount of protected income provided by different annuities in the worst-case scenario when no upside is realized," he says. "This requires combining the rollup-rate and payout rate provisions to see the spending power. This number will generally be lower for variable annuities.

"But then the next step is to analyze the potential offered for step-ups in income if markets do well. With reasonable step-up opportunities, those with the probability-based preferences may start to prefer variable annuities with higher potential payments than fixed annuities."