A quick trip to the online quote generator Vanguard’s web site directs to for an instant IVA quote reveals the following. The same information House Blend located for a fixed SPIA is shown for comparison:
Age ------- Fixed SPIA ------ IVA
Age 60: ... $203,874 ... $191,152
Age 65: ... $176,454 ... $170,862
Age 70: ... $154,050 ... $150,053
Age 75: ... $129,894 ... $126,782
Both the fixed SPIA and IVA provide a first monthly payment of $1,000. The fixed SPIA stays at that level forevermore. The IVA benefit increases each month the investment return exceeds 3.50% on an annualized basis. The IVA benefit stays the same as the prior month if the investment return equals 3.50% on an annualized basis. The IVA benefit decreases from the prior month’s level if the investment return is less than 3.50% on an annualized basis.
So if one purchases the fixed SPIA at age 65, at age 85 he will still receive a monthly benefit of $1,000. If one purchases the IVA at age 65, at age 85 he will receive a monthly benefit of $2,038 if his investment return is 7.25% per year along the way.
And recall that you control the investment allocation, so whether 7.25% is achieved is somewhat in your hands.
House Blend’s analysis regarding rate of return needed to end up with sufficient funds to purchase a fixed SPIA 5, 10, or 15 years in the future while taking withdrawals in the interim is appropriate if one can earn that rate of return uniformly during the withdrawal period. It does not account for “sequence-of-returns” risk. If the asset portfolio from which withdrawals are made declines in the early years and rises in the later years such that the rate of return House Blend calculates is realized on average for the full deferral period, there won’t be sufficient assets to purchase the SPIA.
Additionally, mortality improvement will cause SPIA premiums to be higher to fund the same level of monthly income 5, 10, or 15 years from now if interest rates remain where they are today.
Frugal Al wrote:
"Wow, that is a fairly simplified example. I suspect the mechanics aren't addressed because they can be confusing and obfuscatory. These are bad deals for most people that have planned appropriately and have properly utilized their tax advantaged space. In rare instances they might be appropriate in high tax situations, or for people that are very risk averse. Most people can do better with a balanced portfolio, and possibly the addition of a fixed SPIA.
Every day there's another story on VAs, including insurance companies changing terms, companies getting out of the business, companies concerned about disintermediation and worried they've over hedged with their bond holdings in the midst of rising interest rates and lapsing policies. Even low fee versions are marginal at best. If most people that bought these things had to understand them, there would be few customers. There is no free lunch, and when some customers thought they got one, the insurance companies wanted them back (i.e., changed the terms).”
Actually, for an IVA, the mechanics in the example are the extent of the mechanics.
Frugal Al is instead referring to deferred variable annuities with a Guaranteed Lifetime Withdrawal Benefit (GLWB) rider. With these, one starts with an accumulated value such as $100,000 and is guaranteed to be able to take withdrawals of a certain percentage like 5% or $5,000 per year for life, even if the account value should go down to zero during that time.
These do have high costs, can be confusing and obfuscatory, and tend to be for people that are very risk averse. Frugal Al has his facts straight—it’s just that they pertain to a different product.
Frugal Al is also correct that insurance companies that engaged in the VA “living benefits wars” of the 2000-2010 period offered too generous benefits that were difficult to hedge or simply went unhedged or were improperly hedged. For certain of these, a bear stock market combined with a lower interest rate environment was the perfect storm of disaster. (Guess what happened near the end of that decade?!) Consequently, some VA-writing insurance companies exited the business. Others reduced terms on newly issued policies, such as introducing investment restrictions and lowering the 5% in the above example to something less. Others offered deals to try to buy back these VA “living benefits.”
Again, all these things Frugal Al correctly remembers apply to VA deferred annuities with so-called living benefits. His observations about those are nearly universally shared: high costs, confusing, appeal to very risk averse, etc.
None of those observations apply to an IVA. They aren’t for people who are very risk-averse. No insurer has changed the terms on these. To my knowledge, no insurer has gotten out of this business. An IVA is simply the variable equivalent of a fixed SPIA.
All the bad press on deferred VAs tends to taint anything with the name “annuity” in it. (VAs have been used as asset accumulation vehicles for the much larger demographic of baby boomers still accumulating retirement wealth, and so there’s been a lot of press about VAs. There’s been virtually no press about IVAs, because of the relatively fewer baby boomers taking retirement income relative to those still accumulating wealth and because of the lesser amount of IVA sales relative to deferred VAs. The fact that IVA commissions are significantly lower than deferred VA commissions also plays a role in the relative levels of sales.)
Take an objective look at an IVA (of any company, but take an especially strong look at those with lowest cost). House Blend, if you’re willing to buy a fixed SPIA, would you be willing to buy a variable SPIA that both costs less and has the capacity to significantly increase your income level over time? Would you be willing to buy both?
I’m just an (old) student of retirement income, who took an interest in this subject starting with the 1965 paper by Yaari. People are too quick to dismiss an IVA. The mechanics of an IVA are unchanged from when CREF (of TIAA-CREF) introduced it in 1952. Insurance companies can offer these safely, without any need to buy derivatives or be concerned with where interest rates or the stock market are going—in significant contrast to more recent, less well conceived product designs.