Back-to-Back Bear Markets Would Justify GLWB
May 12, 2008
Variable annuities with “living benefit” riders would be a sound investment choice if two severe bear markets occurred in close succession, according to an article in the May 2008 issue of the Journal of Financial Planning, a publication of the Financial Planning Association (FPA).
In “A Context for Considering Variable Annuities with Living Benefit Riders,” John H. Robinson compares the hypothetical performance of a VA with a five percent guaranteed lifetime withdrawal benefit with the performance of an S&P 500 index mutual fund when their owners retire at the beginning of a bear market.
Robinson described two hypothetical investors: a 55-year-old who accumulates funds in both types of accounts until he starts withdrawing funds at age 65, and a 65-year-old who starts withdrawing immediately. Both investors begin their retirement withdrawals just as they enter one of two bear markets: 1973–74 and 2000–02.
Despite the downturns, neither the index fund nor the variable annuity portfolio (invested in the S&P 500) ran out of dollars. In both scenarios, the investor using the index fund ends up with more money than the VA investor by the end of the study period because of the expense drag of the variable annuity.
But if the 2000–02 decline were followed by, for instance, a 20% decline in 2007, the GLWB would have been in the money and would have protected the retiree from "sequence-of-returns" risk. That's the risk that a combination of withdrawals and negative returns in early retirement could devastate a portfolio and lead to financial ruin.
“While the probability of [portfolio] failure appears low,” he writes, “the effect of premature depletion of one’s retirement savings can be catastrophic, suggesting that retirees may be rational in electing to use living benefit riders as portfolio insurance.”
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