The hottest offering in guaranteed lifetime income plans now is the guaranteed lifetime withdrawal benefit (GLWB). This is a rider to variable annuity policies, and it also is available on some other insurance offerings. GLWB resurrected variable annuity sales after stocks crashed in 2008 and now is attracting even conservative investors. The rider is so popular Vanguard added it to the annuities it sponsors.
The GLWB (sometimes called guaranteed minimum withdrawal benefits, or GMWB) of course is given much catchier names by insurers in their materials, but you’ll recognize it when you see it.
You invest in a variable annuity and elect the rider. GLWB guarantees income for life at a fixed percentage of the initial withdrawal value, which usually is the amount you invested in the annuity. For example, a GLWB might guarantee that a 65-year-old man will be able to withdraw annually up to 4% of the withdrawal value. Invest $100,000 in the annuity and the man can withdraw $4,000 annually for life. Even if the account value drops to zero, the guarantee continues.
But if you withdraw more than the guaranteed amount in any year, the guarantee for subsequent years declines.
Unlike an immediate annuity, when the variable annuity with GLWB still has an account value, the policy owner can withdraw up to the account value at any time, provided any surrender fee period has passed.
Another attraction of GLWB is the potential for the guaranteed amount to increase over time. A variable annuity is invested in mutual fund-like accounts selected by the policy owner from those offered by the insurer. If the investments do well, the account value on which the guaranteed withdrawal amount is based can increase. The guaranteed withdrawal amount usually varies with your age. For example, a 55-year-old might be guaranteed 5% of the amount invested while a 65-year-old is guaranteed 4%. The guaranteed percentages declined at some insurers over the last year in response to the Federal Reserve’s zero interest rate policy.
To sum it up, the GLWB offers guaranteed minimum lifetime income you can never outlive and that might increase. You have access to the full account value if you need it, within the terms of any surrender fee.
Of course, these features aren’t free. You pay the basic costs of a variable annuity. These include the management fees for the investment funds plus the administrative and other fees of the annuity. Together these average 2.49% of the account value annually. The GLWB rider has a separate cost that averages 1.032% annually, according to both Morningstar and the Insured Retirement Institute. These are averages, so you can find higher and lower fees. The Vanguard-sponsored GLWB rider, for example, costs 0.95%, and its average variable annuity expenses are around 0.59%.
You should discount considerably the probability the guaranteed payment will increase. The expenses of the policy are subtracted from the returns, and the increase must meet formulas standards in the policy. To earn an increase, you have to invest aggressively and hope for the best. Insurers are on to that game and in most policies they limit the percentage of the variable annuity that can be invested in stocks and other risky assets. Some even require that all or a portion of the account be invested in diversified portfolios managed by the insurer.
You are very unlikely to see a payment increase, according to Wade Pfau, an academic who also writes a blog and publishes frequently on retirement planning issues. He did a series of projections for GLWB withdrawals based on historic market returns and using the low Vanguard fees. He found there were only three cases in which the subsequent distributions met or exceeded the purchasing power of the first-year withdrawal.
There are two other factors to consider before opting for a variable annuity with GLWB as a source of guaranteed lifetime income.
One factor is inflation. Remember the guaranteed withdrawal is fixed. Its purchasing power will decline over time to the extent there is inflation. Pfau found that in most cases by year 30 the withdrawal had only 20% to 30% of the initial purchasing power.
Of course, that’s also true of immediate annuities, bonds, and other fixed income sources. Be sure you understand this and don’t place too high a value on the guaranteed income feature.
You also need to compare the GLWB to alternatives. One alternative is the traditional systematic distribution plan from a portfolio. In this plan, an annual distribution increases for inflation each year. Also, this plan avoids the higher fees of the variable annuity and the GLWB rider. In his analyses, Pfau found that aside from the deflation experienced by a 1929 retiree, there was no case in which the systematic plan didn’t at least match the distributions from the GLWB. In most cases, the systematic plan did a better job of maintaining the purchasing power of the retiree. There were cases when the retiree ran out of money under the SDP because inflation was high and the retiree had the annual distributions maintain the initial purchasing power. But the SDP gives the flexibility to adjust the distribution amounts in response to market returns and inflation, something the GLWB doesn’t do well.
You also should compare the GLWB to a traditional immediate annuity. The immediate annuity is likely to give you a higher initial payout than the GLWB. It also won’t retain purchasing power in the face of inflation, and you don’t have access to the full account value once payouts begin. (Though many immediate annuities now allow additional withdrawals of up to 10% of principal in a year.) Of course, your heirs won’t inherit any account value with the immediate annuity while they might with the variable annuity with GLWB.
Also consider the inflation-adjusted immediate annuity. Its initial payout will be less than of the immediate annuity, but the income will increase with inflation.
In a previous visit (September 2008) we summarized a debate over whether GLWB is worth its cost. In this visit, we took another approach and compared GLWB to alternatives. Pfau’s concludes that you shouldn’t place much value on the potential for higher withdrawals under the GLWB. He also concluded you’re more likely to generate higher distributions over time investing the money yourself and taking systematic withdrawals. (Remember that Pfau’s simulations used Vanguard’s low-expense product. Other annuities are likely to have higher expenses and thus worse results.)
The GLWB can benefit someone who is extremely long-lived, with retirement extending beyond 30 years. GLWB also is helpful for investors who would be tempted to abandon their investment strategies during sharp market downturns and thereby miss out on recoveries.
GLWB also will be beneficial in an extended period of low investment returns that would make a 4% or 5% guaranteed withdrawal seem high. Also, the guarantee will be attractive in a deflation. But those benefits also apply to immediate annuities.
Of course, the guarantee of the policy is only as good as the insurer making it.
The guarantee in GLWBs is powerful and comforting. Before purchasing one, however, carefully consider the alternatives and be sure you are getting value for the extra fees. A better choice for your situation might be an immediate annuity or a portfolio with systematic or flexible distributions.
I don’t recommend you have only one source of retirement income. You need to structure a program of retirement income sources. Begin with Social Security and any employer pension. Supplement them with other guaranteed income sources such as annuities of your choice and a welluctured portfolio and distribution plan.
RW June 2012.
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