The Elusive Benefits of “Lite” Annuities

The growing focus on lower investment fees is affecting longevity-protected solutions (i.e., annuities). This article explores the benefits of annuities with lower explicit fees, a category I dubbed as “annuities Lite” in a previous article that focused on guaranteed lifetime withdrawal benefits (GLWBs).

While lite annuities have attributes that make them seem more seem attractive, in particular lower explicit fees, the elimination (or reduction) of certain features, whose benefits are often complex and difficult to model (e.g., step-up provisions within GLWBs), can significantly reduce the expected income of the strategy, resulting in an illusion of lifetime income protection.

This article demonstrates that lite annuities are effectively “stuck in the middle” between non-annuity investments and more traditional annuity strategies. Their expected income is likely to be notably lower than other products with more generous benefits, while adding relatively little value beyond a pure unprotected strategy.

While fees are an incredibly important consideration when purchasing any product or investment, financial advisors, plan sponsors and retirees should do extra diligence on longevity-protected solutions with reduced income (but potentially lower fees). They are less likely to offer meaningful longevity protection.

Fees… a race to the bottom?

There has been an increased focus on investment expenses in the asset management industry, especially in the defined contribution (DC) space. For example, the asset-weighted expense ratios for target-date funds, the most popular default investment in DC plans, have declined from 67 basis points (bps) in 2009 to 34 bps in 2021, based on data from the Morningstar 2022 Target-Date Landscape Report.