Exploring Variable Annuity Riders
Over the years variable annuities have had a somewhat spotted history. During the high tax and bull market environment of the 1980’s they became the darlings of financial advisors and investors looking to capitalize on rising stock prices while reducing their taxes. As the proliferation of variable annuity products hit a peak in the 1990’s they came under close scrutiny for their high expenses and their suitability for some investors. In recent years, especially in the aftermath of the recent financial crisis, variable annuities are getting a fresh look as much for the renewed concerns about outliving retirement income as for the availability of new riders that have enhanced their standing as a solid investment vehicle. Here we explore the most important variable annuity riders.
Guaranteed Minimum Income Benefit (GMIB)
The GMIB arrived at a time when variable annuity investors began to feel the pinch of the wild market gyrations on their annuity income payments. While the advantage of variable annuity income stream is the potential for increased payment amounts during rising markets, investors may not have been prepared for the steep drops in market values that they saw in the 2000 decade. The GMIB was introduced to allay the fears of those kinds of market swings by providing a minimum income guarantee regardless of declining market values.
The income guarantee is typically based on the greater of the actual market value of the annuity contract at the time of annuitization, or a fixed rate of interest compounded annually over the accumulation period, or the highest market value of the contract during the accumulation phase. The GMIB provisions vary from one contract to the next, but most of them require that the annuity be in effect at least 10 years (or some specified period) before it can be exercised. They also require that the whole contract be annuitized versus only a partial annuitization. Not all variable annuity providers offer a GMIB, but those that do usually offer them on all of their different variable annuity contracts, except no-load contracts.
Living Withdrawal Benefit (LWB)
The LWB is another rider that investors can purchase if they are concerned with the impact of market declines on their future withdrawals. The LWB ensures that you will receive a minimum withdrawal – monthly, quarterly or annually- for life, even if your account balance falls to zero. The amount of income is typically based on a withdrawal percentage using a minimum compounded interest rate such as 6% or 7%. To determine the guaranteed withdrawal amount, the percentage is based on the higher of the actual account value or the amount the account value would have grown to using the minimum interest rate. Some contracts allow you to “step up” the account value to the highest value attained during the exercise period of the rider. In all cases, once the withdrawals begin, they are guaranteed to continue for life.
Guaranteed Minimum Withdrawal Benefit (GMWB)
The GMWB is similar to the LWB except that it doesn’t provide a lifetime guarantee of withdrawals. The GMWB does guarantee that you can never lose any of your principal and that you will receive a minimum withdrawal payment based on a percentage of your principal balance until you have used up all of your principal and accumulated interest. If the market performs well and you account value increases, even while you are receiving withdrawals, you may have the option of “stepping up” the principal payments to reflect the higher account value. This means that, if your initial payments were based on a $100,000 investment, and your account value grew to $150,000 over a 10 year period, you could increase your withdrawal payment based on a percent of the stepped up account value of $150,000. You would choose a GMWB over a LWB if you preferred that you receive all of your principal and interest within a specified period of time as opposed to over your lifetime. In this regard, the GMWB can generate much higher withdrawal payments.
Guaranteed Account Value (GAV)
The GAV rider guarantees your account value so that it doesn’t drop below the principal balance. It also enables you to lock in a minimum growth rate. In some cases, the GAV will also allow you to step up your account value to lock in market gains. All future withdrawals are then based on the stepped-up account value regardless of whether the market declines. In this regard, a variable annuity with a GAV acts very similar to an indexed annuity, but with greater upside potential.
Weigh the Costs and Benefits
These are very powerful riders, and on their face, they turn an ordinary variable annuity into an extraordinary investment vehicle. But, they do come at a cost. The fees for adding these riders range from .30% to 1.0% of the account value and are deducted annually. For anyone who experienced the market roller coaster of the 2000 decade, they may be well worth the cost. When comparing variable annuity products, it is important to compare the cost of these riders as well as their provisions. For example, each annuity provider will have their own provisions that establish when the riders can be exercised, or how often step-ups can occur, or the minimum holding period before withdrawals can begin. Each rider has specific provisions that should be fully explored and their costs weighed against the benefits they provide.