Why I'm Replacing My Variable Annuity with an FIA by Scott Stolz (week 19)

 

In 2009, at the age of 49, I bought a Voya (previously ING) Architect Variable Annuity just before Voya undertook a series of product changes to lower the amount of guaranteed income provided by the lifetime living benefit feature.  The policy was bought in my custodial IRA account.  My plan was simple.  Start the income at the age of 59 ½ (the earliest age I could begin the lifetime income payments) in order to liquidate the annuity as quickly as possible.  Once the account value reached $0, I would continue to get my lifetime monthly income out of Voya’s general account rather than my own money. 

At this point, I need to provide a little educational content on annuity living benefits for those reading this that are not familiar with this concept.  Most annuities today come with an optional living benefit feature that can be tacked on to the policy for an additional charge – usually 1-1.5% per year.  This feature allows the policyholder to take a specific amount out of the policy each year for as long as that policyholder lives.  Because you don’t know how long you are going to live and you don’t know what returns you will get each year, the risk of any annual systematic withdrawal from a financial account is that you end up liquidating that account before you die.  This feature guarantees that if this occurs, the insurance company will continue to send you the annual income out of its pocket.  One can therefore think of the annual fee for this rider as an insurance premium to guarantee the income for as long as you live regardless of how fast or slow the account value grows.

The insurance company is essentially betting that this will occur very rarely, and for the few times it does occur, the annual fees they will collect will provide ample funds to make the remaining lifetime income payments.  By taking the money as soon as possible, my goal was to maximize the likelihood that this will occur.

One other important fact on how this feature typically works.  In most designs, the insurance company calculates a second value called the income base.  The amount of income you receive each year is actually a percentage of this income base, not your account value.  This income base is guaranteed to grow at a specified rate each year until you decide to start taking your income.  This means each year you wait to start taking the income, the more income you will eventually get – just like Social Security.  In addition, the percentage of the income base you can take also increases as you age, thereby further increasing your income.  There are two reasons the insurance company is willing to give you more income the longer you wait to start the income.  First, the older you are, the less years you are going to live and therefore they can simply afford to give you more money for your remaining years.  Second, at some point your life expectancy will get so low that there is simply no way you will liquidate your account before you die.  Therefore, they dangle more income in front of you as an incentive to continue to wait.

Because the income base grows at a guaranteed specific rate, it’s possible for it to grow faster than your actual account value.  That’s what happened in my case.  When I turned 59 ½ ten years after I bought the contract, the income base was 195,000 and my account value was only $175,000. (If you noticed that I did not put a “$” sign in front of the income base, that is not an error.  The income base is not money.  It’s just a value that is used to calculate my annual income – like credit card points is a value used to calculate your reward.)  At 59 ½ I was allowed to take 5% of the income base, or $9,750 per year.  But since my account value was only $170,000, I was actually taking 5.7% of my actual money.  Very few financial advisors would think it’s a good idea to take a 5.7% annual systematic withdrawal at such an early age.  The general rule of thumb is to take 4% each year.  The odds of liquidating the account simply become too great if you take 5.7%.  But remember, that was my goal.

Since I was still working, I did not need the income from the annuity, therefore I had the income payments paid back into the custodial IRA as an IRA transfer in order to avoid taxes.  I then simply reinvested the income payments each year into stocks.

But now, after 6 years of income payments, I have decided to abandon my original strategy.  Despite the terms of the income rider limiting me to a 60/40 investment mix and taking annual withdrawals, the strong stock market has caused my account value to continue to grow.  Now that my account value is just shy of the income base, my current systematic withdrawal rate of the account value is now down to 5.2%.  Therefore, the odds of me liquidating the account value before I die, is much less than it was six years ago.

Now one might argue that a 5.2% systematic withdrawal rate for life at the age of 65 is still a good deal.  And I wouldn’t argue with that.  But one other thing has changed.  Interest rates are higher, and some insurance companies are paying more generous income on their fixed indexed annuity (FIA). 

To find out what FIA I selected and how the income compares to my current variable annuity, you’ll have to tune into next week’s blog.  This week’s is already too long.