GMWB Issue: What If For Life Is Not Enough?

In anticipation of trillions of dollars of retirement savings distributions over the next few decades, the variable annuity industry is focusing a great deal of attention on products offering Guaranteed Minimum Withdrawal Benefits.

These benefits guarantee a minimum amount of periodic partial withdrawals, regardless of the variable annuity’s actual account value.

GMWBs have been available in the market for about five years and have been the key driver of variable annuity sales during the last two years. The type of GMWB innovation currently receiving the most attention is the “GMWB for life” feature.

The GMWB for life guarantees a minimum amount of annual income for the life of the annuitant. The guaranteed payment is typically calculated by multiplying a benefit base times a maximum withdrawal percent.

For example, a 5% for life GMWB with a $100,000 initial premium would guarantee $5,000 per year for the remainder of the annuitant’s life. Such GMWBs have been presented as an alternative to contract annuitization, with the added benefit of continued liquidity.

This liquidity comes at a price, however, in that exclusion ratios do not apply to such partial withdrawals under the federal income tax code. That means these for life partial withdrawals are fully taxable to the extent they consist of contract gains.

GMWB issuers continue to strengthen their retirement saving distribution story with significant innovations in a number of areas.

Even with all this excitement about for life GMWBs, however, one concern has emerged about GMWBs. This is that the for life measure only considers a single annuity or ends upon the first death for joint-annuitants, while the typical VA contract is either single or jointly owned with an annuitant and a beneficiary that are a married couple.

A major variable writer recently has filed a GMWB for life that offers both a single-life and a joint-life version. The joint-life version costs 15 basis points (.15%) of benefit base more than the single-life version and requires that the younger of the joint lives be at least age 55 at the time of first withdrawal. The maximum withdrawal percentage varies from 4.0% to 6.5% based on attained age of the younger joint life. The contract features annual step-ups on the benefit base and requires participation in one of five asset allocation programs.

Other GMWB for life writers have addressed this issue through spousal continuance provisions. Some GMWBs allow a surviving spouse to continue to receive the guaranteed withdrawal until the entire benefit base has been withdrawn. Still other contracts allow a surviving spouse essentially to restart the GMWB at the account value at the time of the annuitant’s death.

Another criticism about some GMWBs is that a significant penalty may be assessed if a partial withdrawal greater than the maximum annual withdrawal is taken. This characteristic has been troubling particularly in situations where the excess withdrawal is driven by required minimum distribution (RMD) requirements on tax-qualified contracts.

Many of the more recent GMWB benefits have been created to be “RMD friendly.” Such benefits accomplish this by treating any withdrawals made because of RMD requirements as not being excess withdrawals; consequently they avoid any punitive GMWB treatment.