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"Our research shows two issues that are top-of-mind for boomers," says Corey Walther, senior vice president of strategic accounts at Allianz Life in Minneapolis. "They are most worried about outliving their assets and about the effects of inflation on their retirement income."
They could address the fear of outliving their assets by buying an immediate annuity, which would deliver lifelong cash flow. Immediate annuities, though, remain among the most talked-about but least-used investment vehicles in the market.
"Many people are reluctant to annuitize assets in their portfolio," notes Kevin Hogan, senior vice president of insurance and annuity product marketing at LPL Financial Services in San Diego. "They don't like the loss of control that annuitization brings."
THE GUARANTEE RIDERS
The problem with immediate annuities is investors don't want to hand over a lump of cash to an insurance company and then never see it again except in meager annual payouts. The insurance industry has come up with a solution, which is to offer riders on variable annuities that guarantee lifetime withdrawals but let the clients hang on to their portfolio assets. These guaranteed minimum withdrawal benefit riders, known as GMWBs, have mushroomed in popularity and are now more common than their predecessors, which guarantee minimum income benefits (GMIBs) and minimum accumulation benefits (GMABs).
A GMWB guarantees that investors can withdraw a guaranteed fixed percentage--generally 5% to 7%--of the annuity premiums for a specified period until the entire amount of paid premiums has been withdrawn, regardless of market performance in the underlying funds. A GMWB-for-life guarantees a somewhat lower withdrawal amount for life, even after the premium is repaid.
A GMIB guarantees that when a contract is annuitized, the income payments will be based on the greater of the actual contract value or a minimum payout base. This base typically equals the amount invested credited with a competitive rate of interest (5% is common). A GMAB guarantees that the variable annuity contract value will be at least equal to a certain minimum amount (usually the premium amount) after a certain number of years, regardless of actual performance.
Consumers worried about outliving their assets are scooping up GMWB in growing numbers. "Lifetime guaranteed minimum withdrawal benefits are becoming the most widely available living benefit," says Frank O'Connor, product manager for VARDS (Variable Annuity Research and Data Service) Products at Morningstar in Chicago. In the first three quarters of 2005, nearly 80% of all variable annuities sold to individuals included a GMWB benefit. That was far ahead of GMIBs, at 45%, and GMABs, at 37%. As recently as 2003, GMIBs were the most widely available living benefit packaged with variable annuities.
"Given that GMWBs fast became the most widely available living benefit and that their availability has continued to grow, I think you can infer that they're the most widely elected, too," O'Connor says. "If election rates were low, we would be seeing at least some instances of the benefit being removed from actively sold contracts, and that hasn't happened." The Hartford, a leading issuer of GMWBs, says that about 70% of its variable annuity customers elect some sort of guaranteed withdrawal benefit.
A LIFETIME GUARANTEE
The basic GMWB was essentially a return of principal. For example, a client who invested $100,000 in a variable annuity with this rider might be able to withdraw up to $7,000 (7% of the original outlay) per year, no matter what happened within the chosen investment accounts. The guarantee would be in place until the $100,000 investment was withdrawn.
A new twist on this innovation can make the GMWB good for life. "Some newer variable annuities have made this a lifetime guarantee, usually with a lower withdrawal percentage," says Mark Smith, a financial planner in Englewood, Colo. Instead of being able to withdraw $7,000 for 14-plus years, until $100,000 has been pulled out, an investor selecting this new rider might be able to withdraw $5,000 for 20, 30 or 40 years or more, as long as he or she remains alive.
Such guarantees can allay retirees' fear of outliving their money. "Planners can't control all the variables," says Scott Sanderson, vice president of marketing and strategic relationships for The Hartford's investment products division in Simsbury, Conn. "If we take longevity off the table, we can remove one of the most important unknown variables, which will then help financial planners. Insurance firms are uniquely positioned to do this, by pooling their longevity risk."
Various insurers have taken different approaches to GMWB-for-life riders. ING, for example, sets the guaranteed withdrawal rate at 4% for those who start the cash flowing in their 50s and up to 7% for withdrawals beginning at age 80. "That percentage stays the same, as you grow older," says Ann Cutts Hughes, senior vice president for business development at ING annuities in Dallas. "However, it's possible for the guaranteed amount to increase, if the account value grows."
That ability to increase the withdrawal amount through appreciation in assets can ease retirees' other financial fear--losing ground to inflation. "You might be guaranteed $5,000 withdrawals each year from a $100,000 investment," Hogan says. "At a certain future date, if your account has grown to $200,000, your guaranteed withdrawal would increase to $10,000 per year with some of these riders."
Typically, annuitants have some flexibility about when to exercise such a rider. "Our annuity lets you defer withdrawals until you need them," says Matthew Sharpe, chief marketing officer of the retirement income and investments division at Genworth Financial in Richmond, Va. "You can stop the withdrawals and then start them up again. These riders fit nicely in a space between annuitization and straight withdrawals."
So far, this hybrid seems to appeal to investors. "GMWBs-for-life are the new annuitization," Hogan muses. "In my opinion, that's why they're so successful. They offer the same guarantee of lifetime income that investors would get by annuitizing, yet there's not the same loss of control."
Buying a variable annuity with a GMWB-for-life rider entitles a client to lifetime withdrawals, some ongoing control and the possibility of increased payouts over time. On the other hand, they are also hard to explain, may be costly and aren't right for all clients, according to some advisers.
COMMUNICATION GAP
Many purchasers of variable annuities with GMWB riders don't understand what they're buying, says Steve Delott, a planner in Rolling Meadows, Ill., who's affiliated with National Financial Partners. "Almost invariably that annuity owner will be talking in terms of a guaranteed rate of return," he says. But living benefits don't guarantee a specific return. It's really more of a money-back guarantee.
The insurance companies aren't to blame for this misunderstanding, says Delott. By the time that the GMWB rider is explained, from the insurer to its wholesalers to brokers and ultimately to the investor, the nuance tends to get lost. The rider offers a right to withdraw 5% of the initial investment each year, regardless of subaccount performance, but the buyer thinks that a 5% return is being guaranteed, Delott says. "This is the most misunderstood variable annuity benefit, from what I've seen."
Delott prefers equity indexed annuities to variable annuities with living benefits, "With this type of fixed annuity, you don't have to worry about the account going down, you have exposure to equity markets and the costs are lower," he says.
STEEP COSTS
Indeed, the costs of variable annuity guarantees are important for planners to consider. "On the face, these living benefits sound very good, but I'm skeptical," says John Henry McDonald, president of Austin Asset Management in Austin, Texas. "It can be hard to understand some of these contracts, and you have to look carefully at the total cost." McDonald has appeared as an expert witness in cases involving variable annuities.
Smith puts the average cost of a basic annuity at about 1.4% a year for mortality and expenses plus an average of 0.75% for a growth fund sub-account. "That's a total of about 2.15%, compared with a 1.4% expense ratio for the average growth mutual fund. The extra cost is 0.75%, which hopefully includes an adviser's ongoing counseling," Smith says. Living benefit riders cost approximately 0.5% more.
"The only reason to buy a variable annuity now and pay the extra costs--which can be huge after compounding--is to get a guarantee," Smith says. "Not everyone needs a guarantee, but there are people who do. During the last bear market, many investors wanted to get out of equities, and the only way I could keep them in the stock market was with a variable annuity. Now, such clients are way ahead of where they would have been otherwise, so they're pleased."(For a more thorough discussion of variable annuity costs, see "Fee Factor" below.)
THE RIGHT CLIENTS
Some investors can benefit from these guarantees, says Tom Payant, a planner in Sun City Center, Fla. "We have used Hartford's GMWB in the past, and we plan to take a close look at the new rider guaranteeing lifetime withdrawals," he explains. "We're thinking about using it for some of our clients, pre-retirees and early retirees in their 50s and 60s, who are legitimately concerned about running out of money."
If his analysis shows that clients need another $25,000 of income per year, for example, they might invest $500,000 in this annuity to get the 5% lifetime withdrawals, Payant explains. On the other hand, a GMWB-for-life rider might not make sense for older clients with short life expectancies.
Smith also has yet to sell a variable annuity with a guaranteed lifetime withdrawal benefit, but he might after weighing the investor's age and the promised withdrawal rate. "I would want to know that the client will take withdrawals and spend the money in retirement," he explains. "Such a rider would work best for clients who are in good health, with family histories indicating that they're likely to live a long time and exceed their life expectancy."
Similarly, Norm Mindel, a planner with Genworth Financial in Schaumburg, Ill., believes that GMWB-for-life variable annuities are not for everyone. "But they may be suitable for clients where retirement income is an issue," he says.
Mindel points to research indicating that retirees should not withdraw more than 4% or 4.5% of their portfolios in the year they stop drawing paychecks, followed by increases for inflation. "Most clients are quite surprised at the 4.5% limit," he says. "A variable annuity with a lifetime withdrawal guarantee is a product that planners can use to show the recommended withdrawal rate that will ensure that their money will last over their lifetime. Overcoming client's reluctance to annuitize is a major feature."
Mindel acknowledges that the cost of such a guarantee will be a drag on the contract's accumulation. "It's an insurance cost for planners and their clients to consider," he says. "What exactly is the right price for making sure you never run out of money?"
O'Connor sums up the pros and cons for such lifetime guarantees. "On the one hand, you can take the position that someone with a well-constructed portfolio will not need to pay for that protection, especially over a long time period. On the other hand, all things are possible. People who pay for fire insurance don't complain if their house doesn't burn down."
At New York Life, Corey Multer, vice president of individual annuities in Sleepy Hollow, N.Y., is not sure that investors who buy GMWB-for-life riders are getting the right insurance at the right price. "We're still looking at withdrawal benefits, trying to get comfortable with their value for the annuity owner. So far, we have not gone in that direction." Financial planners contemplating such riders should take a hard look at the features and costs to protect their clients from having withdrawal pains.
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