Variable Annuity Living Benefits: An Income Hedge For The Everyday Investor
Mark R. McManus

Despite the tumultuous times on Wall Street, one investment product can soothe the jitters of retirees. Providing a guaranteed investment value or income payment, a variable annuity with a “living benefit” provision is an excellent hedge for the everyday investor. This investment tool also protects against inflation, and is a way to provide income flow for retirees with longer life expectancies.

A living benefit is a rider added to an annuity contract that provides guaranteed income, regardless of the results of the underlying mutual fund sub-accounts. The fee for a living benefit is added to the base mortality expense and administration cost of the annuity contract, and generally ranges from 0.40 percent to 0.95 percent of the rider value.

Living benefits fall under three general categories:

  • Guaranteed lump sum withdrawal in the future (known as Guaranteed Minimum Accumulation Benefits);
  • Guaranteed income payments for life or a specified number of years (Minimum Guaranteed Withdrawal Benefits); and
  • Guaranteed annuity value at a future point (Guaranteed Minimum Income Benefits).

This article focuses on Lifetime Guaranteed Withdrawal Benefits (LGWBs) and Guaranteed Minimum Income Benefits (GMIBs). While these guarantees vary by insurance company, the basic concept is the same. The pre- or post-retiree invests in a variable annuity with a living benefit guarantee provision. The living benefit rider guarantees that income will accumulate and pay out at a contractually guaranteed rate (usually between 5 to 7 percent) irrespective of how the underlying mutual fund sub-accounts are performing.

In addition to the income accumulation and payout rate guarantees, these benefits allow the investor to lock in the investment gains by way of a withdrawal/income value tied to the performance of the underlying mutual fund sub-accounts. The investment gains can be measured on a monthly, quarterly or annual basis.

For example, let’s say a 60-year-old retiree invests $300,000 in a variable annuity with a LGWB rider, and begins taking immediate monthly withdrawals of $1,500 (6 percent of the initial $300,000 investment divided by 12).

Due to the $1,500 monthly withdrawals and poor investment performance, the mutual fund sub-account values fall to zero at the end of the 14th contract year. If this were a standard mutual fund, the now 74-year-old retiree would be out of income from the investment.

However, the LGWB requires the insurance company to deliver on its contractual obligation and continue paying $1,500 per month for the life of the owner (or joint owners if elected). If this were a dollar-for-dollar GMIB, then the insurance company would “annuitize” the $300,000 income base and continue to provide income for life. Additionally, had the annuity’s mutual fund sub-account values experienced market gains that increased the contract value over $300,000 on a contract anniversary, then that value could be locked in and become the new benchmark for the 6 percent income payments. If the annuity’s mutual fund sub-account values experienced market losses that dropped the investment value below $300,000 on a contract anniversary, then the original $1,500 monthly income payment would continue.

In other words if the investment value goes up, the income payment goes up, if the investment value goes down, the income payment does not.

Because of these income guarantees, variable annuities have become increasingly popular over the past several years with both financial advisors and investors. One of the major reasons for the increased interest in variable annuities is that baby boomers, 76 million strong, are either retired or are approaching retirement.

Another reason may be the need for retirees to manufacture their own pension income. With defined benefit plans going the way of the video tape in favor of 401(k) plans, employers have now shifted the onus and risk of establishing guaranteed retirement income to employees.

Still another reason may be the “retirement catch 22” – the investor’s hesitancy to expose their retirement assets to the stock market for fear of loss of future income, while understanding their need to expose their portfolios to stocks in order to keep pace with inflation.

In this world of increased stock market volatility and longer life expectancies, the need for variable annuities with income guarantees will continue to rise. Insurance companies will continue to develop income-focused products as they try to capitalize on opportunities in the wealth-transfer market and distribution of multi-trillion dollars of retirement income.

Mark R. McManus is vice president of annuity sales and marketing for Baystate Financial Services, LLC in Boston, and is a registered representative of New England Securities in Boston. He can be reached by email at mmcmanus@baystatefinancial.com



    

© 2009, France Publications Inc.
3500 Piedmont Road, Suite 415 • Atlanta, GA 30305
(404) 832-8262 • fax (404) 832-8260