New Approaches to Retirement Income

Utilizing the benefits of Investment-Only VAs

by Laurence Greenberg

Mr. Greenberg is President of Jefferson National, innovator of the first flat- fee investment-only variable annuity with the industry’s largest selection of underlying funds, named to Barron’s list of Top 50 Annuities for a second consecutive year. For more information, please visit or call 1-866-WHY-FLAT (866-949-3528).

Over the next decade, more than 10,000 Baby Boomers will turn sixty-five every day. One of out every four 65-year-olds today will live past the age of 90, and one out of 10 will live past age 95. As this generation anticipates living decades longer after leaving the workforce, they share one common fear: outliving their retirement savings.

The retirement income challenge is real: the Employee Benefit Research Institute reports that only 13 percent of American workers are very confident they will have enough money for a comfortable retirement. And advisors share their concerns. According to 71 percent of the RIAs and fee-based advisors surveyed by Jefferson National, the three biggest challenges to generating retirement income today are confronting a low-yield market environment, managing ongoing volatility and maintaining adequate equity exposure. Clients and advisors alike are demanding innovative solutions.

Challenges to a Traditional Approach

Variable annuities (VAs) were introduced in the mid-1950s as a tax-deferred savings vehicle. Then, in the late 1990s, companies began to offer variable annuity products with insurance guarantees, as a way to boost sales. Variable annuities quickly became a trillion-dollar industry by 2000. These traditional VAs with income guarantees became tremendously popular among advisors and investors alike, because they promised downside protection, with some upside potential and a guaranteed income stream, all in one single investment product.

But the Crash of 2008 changed the landscape, according to the recent whitepaper, “A New Approach to Retirement Income: Next-Gen vs. Traditional VAs,” written by retirement income professor Wade Pfau, Ph.D., CFA and released by Jefferson National. Faced with volatile markets and low yields, many VA companies were forced to shift risk off their balance sheets and onto fund companies. Others were forced to cut benefits, raise fees, restrict investment allocations, re-tool products and renegotiate guarantees. Some were forced to leave the industry altogether.

While insurers have continued to offer traditional VAs with income guarantees, many have raised asset-based fees to more than two or three percent annually. But the negative impact of high fees, compounded by today’s challenging market dynamics, can diminish returns on these retirement income accounts, erode the underlying assets and drive the ending balance to zero more quickly, according to Pfau’s research.

While 51 percent of advisors surveyed by Jefferson National continue to use guaranteed VAs today, more than two thirds have concerns about rising fees and declining benefits. Likewise, more than half of their clients share the same concerns. This has led to the growth of a new category of VAs.

Growth of a Next-Generation

Advisors have consistently recognized the power of tax deferral to optimize investment performance and maximize accumulation of assets. Today, more than 85 percent of advisors say tax deferral is one of the best ways to accumulate more retirement savings according to a Jefferson National study. And research has shown how tax-deferred vehicles, such as a low-cost, no-load VAs have the potential to increase returns by 100 bps or more – without any subsequent increase in risk. This has led to a new approach to generate retirement income: the Investment-Only Variable Annuity (IOVA).

This new category of IOVAs was introduced in the mid-2000’s. And the category has continued to grow rapidly, nearly doubling in the past two years, with sales of nearly five billion as of Third Quarter 2014 compared to sales of two billion as of Year End 2012.

IOVAs serve as a tax-advantaged investment account, one that can adapt to a wide range of unique asset management strategies and risk profiles, generate income and support a systematic withdrawal strategy – without the added cost of income guarantees. IOVAs eliminate insurance riders, minimize layers of asset-based insurance fees, or even offer flat-fees. The best of these low-cost investment vehicles provide a broad range of underlying fund choices, including liquid alternatives that use unique strategies favored by hedge funds and other elite institutional investors.

only 13 percent of American workers are very confident they will have enough money for a comfortable retirement

The lower cost of IOVAs helps maximize tax-deferred accumulation, to generate reliable income and build more long-term wealth. And with low or no commissions, some IOVAs are built expressly to meet the unique needs of today’s growing number of RIAs and fee-based advisors – and designed to provide greater consumer value.

Choosing an Approach: Guaranteed VAs vs. IOVAs

To compare traditional Guaranteed VAs and innovative IOVAs, Pfau ran 5,000 Monte Carlo Simulations using more than eight decades of market data to test a variety of investor scenarios. His research concludes that just as the power of tax-deferred compounding can grow wealth, its corollary is that the drag of compounding fees can reduce wealth. There can be more efficient ways for clients to generate income, obtain upside potential and downside protection, than by using a guaranteed VA for certain market cycles and/or client profiles.

Specifically, Pfau’s data reveals that while a VA may provide guarantee income even if the account balance falls to zero, its high fees wipe out the value of tax deferral, significantly erode portfolio performance and send the ending balance to zero more quickly. The low-cost of an IOVA, on the other hand, increases the benefits of tax deferral and improves the chances of accumulating more wealth—making them particularly useful for clients with liquidity needs, legacy plans or an interest in keeping pace with inflation rates.

Making an Informed Decision

Jefferson National developed the Retirement Income Calculator, an interactive tool that allows advisors to compare retirement income strategies based on their clients’ specific financial profile. This calculator, using in-depth actuarial research on the cost and benefits of guaranteed products, allows advisors to perform a comprehensive stress test on more than 30 different products from the five top-selling VA providers.

Advisors can run their own customized Monte Carlo simulations using real market conditions, to make an informed decision on behalf of their clients. Calculator outputs include hypothetical performance, lifetime income potential and cumulative fees of Guaranteed VAs versus IOVAs.

This Retirement Income Calculator reflects Pfau’s findings. In the majority of scenarios, clients will pay far more in fees than they ever receive in income when using Guaranteed VAs. Meanwhile, by eliminating asset-based insurance fees, IOVAs allow clients to accumulate more wealth and have the potential to generate more retirement income. When evaluating a range of assumptions, from standard scenarios to more strenuous scenarios, calculator findings illustrate the added value of using Investment-Only VAs.

Innovating in the New Year

The benefits of growing more wealth and generating retirement income with the innovative approach of an IOVA are crystal clear. Yet nearly 60 percent of advisors say their clients have no knowledge about tax-deferred vehicles beyond 401(k)s and individual retirement accounts (IRAs), according to a recent survey from Jefferson National. That means many clients could be leaving thousands of dollars on the table every year – and hundreds of thousands over their lifetime. In this New Year, by adopting a new approach to retirement income and using low-cost IOVAs, you can confront a low-yield market environment, manage ongoing volatility, maintain adequate equity exposure and mitigate the impact of today’s higher tax rates, to help your clients navigate a complex market environment and take on the retirement income challenge. ♦





Important Disclosures:
Variable annuities are investments subject to market fluctuation and risk, including possible loss of principal. Your units, when you make a withdrawal or surrender, may be worth more or less than your original investment.

Variable annuities are long-term investments to help you meet retirement and other long-range goals. Withdrawal of tax-deferred accumulations are subject to ordinary income tax. Withdrawals made prior to age 59 ½ may incur a 10% IRS tax penalty. Jefferson National does not offer tax advice. Annuities are not deposits or obligations of, or guaranteed by any bank, nor are they FDIC insured. There are no additional tax benefits associated with using a variable annuity inside a qualified plan.