FACT #1: The economic benefit of payments under a Guaranteed Lifetime Withdrawal Benefit rider (GLWB) doesn’t materialize until after you’ve received your principal and all of your earned interest.
Here’s an example: At your age 55, you deposit $100,000 into a deferred annuity with a GLWB rider that guarantees a “roll up” interest rate (on the “benefit base”, on which the withdrawal payments are calculated) of 7.2%, compounded for ten years (which is the same as 10% simple interest). That produces a benefit base of about $200,000 after ten years. At that point (when you’re age 65), you begin taking your guaranteed withdrawals of 5% of that benefit base ($10,000 each).
When does the rider begin to “pay off” (give you money that wasn’t yours already)? You might say, “After 10 years”, because at that point, you’ve received $100,000, your original principal. That’s true, if you ignore any interest your money earned (or could have earned). But if you assume that your annuity will earn 3% per year, the economic value of that rider (its “Internal Rate of Return”) will exceed 3% only in the 28th year (when you are age 82), when the annuity’s contract value will fall to zero (due to the fact that the withdrawals were larger, each year, than the interest earned, so the annuity lost value each year from age 65 onward).
If we assume that your annuity will earn 4% per year, those same GLWB payments of $10,000 each will not exceed a return of 4% until year 34, when you’re age 88 (and when the cash value of the annuity will fall to zero).
If we assume that the annuity will earn 5% per year, the GLWB payments will not generate a return of more than 5% until your age 100 (the year when the contract value will fall to zero).
Does this mean that the GLWB wasn’t “worth it”? Not necessarily. It’s absolutely essential that we understand that no pure insurance product will EVER be profitable for the average buyer. If the average purchaser of any insurance product profits from buying it, the insurance company will go broke! The GLWB rider is longevity insurance. For those buyers who live beyond life expectancy (which, not coincidentally, is just about when the annuity earning 3% per year, with a 5% GLWB will run out of money), those GLWB payments will represent “the insurance company’s money” and will continue for as long as they live. That assurance will, for many consumers, be worth the cost of that GLWB rider.
But it’s also absolutely essential that we (you, the prospective buyer of an annuity with this benefit, and the agent who is recommending it) acknowledge that the “rollup rate” on the rider’s “benefit base” is not an investment return. It is very unlikely that the return generated by those GLWB income payments will ever reach the “rollup rate”. It’s also very unlikely that the amount of those payments will ever increase, once payments have begun. This is because for such a “step up” to occur (a condition where the annuity’s cash value exceeds the current “benefit base” and the insurer honors its promise to increase, or “step up” that benefit base to equal that cash value), the annuity must earn more than the sum of the rider cost plus the amount of the GLWB payment.
The GLWB is sometimes presented as being a benefit “almost too good to be true”. It certainly does not generate a “return” even close to that “rollup rate”. But that’s OK. No fully guaranteed instrument could possibly do so in today’s interest rate environment. The Guaranteed Lifetime Withdrawal Rider is, as we noted, longevity insurance. But unlike a Single Premium Immediate Annuity or a deferred annuity that has been placed under an annuity payout option (i.e.: has been “annuitized”), a deferred annuity with this rider offers both an assurance of an income for life and opportunity to access cash values over and above the GLWB payments. Of course, such access (withdrawals of more than the GLWB percentage – in this case, 5% of the benefit base – will reduce future GLWB payments, so that opportunity should be taken only when you understand fully what it will do to your future income guarantees.
In future installments, I will discuss other facts about annuities that you should know.
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