In this post, the third in our series of blogs on what advisors need to know about variable annuities, we will examine the mechanics of the guaranteed lifetime income benefit (GLIB))—where it works and where it fits into the variable annuity landscape..
A variable annuity with GLIB provides the ability to convert an account value to a guaranteed income stream for life through converting the account value into a fixed annuity. The account value typically has a high-water feature and the annuitized value is based on this amount regardless of the actual account value. With a GLIB the underlying account grows each year based on the performance of the underlying investment portfolio. Many times there is a guaranteed roll-up rate applied to the initial investment for a given period. This functions to set a minimum high-water mark value where growth is set as the greater of the guaranteed rate or the actual performance. The highest account value attained through this roll-up phase is saved as the high-water mark and income benefits are ultimately calculated based on this amount.
Withdrawals can begin two ways. One is by annuitizing the account based on the high-water mark at the annuitization rate specified in the VA contract. These fixed payments are made for life in nominal dollars. The second way is to take “dollar-for-dollar” withdrawals. This approach allows the investor to withdraw an amount each year up to the guaranteed growth rate without triggering annuitization. Both options are discussed below.
Most providers who pay a guaranteed roll-up rate for a period prior to annuitization typically use an annuity factor to calculate the payments based on the rate for an age that is lower than the investor’s current age. For example, some policies may state the interest rate assumption used (typically low) and some age offset (if the investor is 72 then the annuity price for an investor 10 years younger is used). The payment is much less than could be achieved in buying a similar fixed annuity in the open market with the same dollars. For example, the current difference between the payouts for single premium immediate annuities is $6.10 per $100 invested for a 70 year old and $5.20 per $100 invested for a 60 year old.
Depending on the size of the gap between the actual account value and the high-water mark, the income payments may not be any higher in the policy than what could be achieved by using the actual account value to buy a fixed annuity policy at current market rates.
Aside from annuitizing the contract, another way to extract value is by using dollar-for-dollar withdrawals. With this method the policyholder can make withdrawals from the account, and as was explained regarding a GLWB in the second post in our series, the investor is paying himself from his own principal. The withdrawals typically can’t be larger than the guarantee without triggering other events like lowering the guaranteed high-water mark.
Using this method preserves access to the account value but the guaranteed high water almost never increases. Remember, there are two values: the “shadow value,” which is the account’s high-water mark, and there’s the actual account value. While the investor gets withdrawals without triggering annuitization, the actual account value continues to diminish. Once the investor has exhausted the account value, specific triggers kick in and the annuitization of the high-water mark starts automatically.
To access the high-water mark on a policy with a GLIB one or the other of the two methods described will have to be used to begin taking withdrawals. Which to choose depends on the size of actual account value relative to the high-water mark, the maximum dollar-for-dollar withdrawal allowed in the contract, the annuity factor used to convert the high-water mark to an annuity and the age, health and liquidity needs of the investor.
I hope that has helped you arrive at a better understanding of how your clients can extract the most value from their variable annuity contracts. In the next installment in this series, we’ll take a look at variable annuities in the real world and how they fit in the markets we’ve experienced over the last few years.