Variable annuity issuers generally offer 3 types of guaranteed living benefits: guaranteed minimum income benefits (GMIB), guaranteed minimum accumulation benefits (GMAB) and guaranteed minimum withdrawal benefits (GMWB).
The typical GMIB entitles the owner to annuitize after a specified period. The payments are based on the greater of actual contract value or a payout base (usually the premiums paid credited with a stated rate of interest).
Typical GMABs guarantee that the contract value will be at least equal to the initial investment after a specified period, regardless of market performance. If it is not, the insurance company will automatically increase the account to bring it up to the guaranteed minimum.
Finally, GMWBs guarantee the systematic withdrawal of a certain percentage of premiums annually, again regardless of actual performance. Early GMWB designs guaranteed annual withdrawals of a specified percentage–usually 7%–until the original investment had been fully recovered.
More recent versions of GMWBs offer a guaranteed lifetime withdrawal benefit (GLWB). This guarantees withdrawals for life, regardless of subsequent account value. The annual maximum GLWB amount typically ranges from 4% to 7% of the benefit base; the percentage varies based on age when the first withdrawal is taken.
These living benefits, which provide principal protection against downside market risk during the contract owner’s lifetime, have been the dominant driver of VA sales over the last 4 years. Despite the stock market’s recovery and recent positive returns, the persistent choppiness of the market and lingering memories of the bear market of 2000-2002 continue to fuel investors’ desire for retirement products with these types of guarantees.
It appears that many investors remain reluctant to invest in the equity market for fear of losing money, notwithstanding the fact that this market has historically produced the highest returns. Guaranteed living benefits on VAs give people the needed confidence to participate in the market, since they know they will be protected against financial loss in the event of untimely downturn during their lifetime.
The strong appeal of the protections provided by living benefits can be seen in recent industry sales figures.
In 2003, approximately 50% of new VA sales were from contracts providing some form of living benefit guarantee.
By 2005, according to a survey on guaranteed living benefits conducted by Milliman Inc., the percentage of total VA sales of contracts offering a living benefit was up to 87%. The survey found this figure had further increased to 89% during the first half of 2006.
Milliman also found that actual election of living benefit riders by VA purchasers has increased, as well. In 2004, 56% of purchasers chose a form of guaranteed living benefit. This percentage increased to 68% in 2005, and to 72% over the first 6 months of 2006.
The increase in election was most evident with the GMWB and GLWB features. Here, election rates have risen from 24% in 2004 to 35% during the first 6 months of 2006.
GLWBs are viewed by some as an alternative to traditional annuitization. Many investors find them appealing because the features allow the owner to maintain greater control of the account than other payout choices. For instance, with a GLWB, the contract owner has a number of options that are not typically included in a payout annuity, including those shown in the chart.
Further enhancements of GLWB benefits are likely. The early GLWB designs were based on withdrawals taken over the lifetime of a single person. A number of newer versions also offer joint life options.
Future design changes may include increases in the benefit percentage. These could be contingent on some event occurring, such as long term care, critical illness or disability. Some kind of inflation protection may also appear.
Annuitization should, however, still remain an attractive option for many retirees seeking a source of lifetime income.
A life annuity will generally provide higher income payments and, if purchased with after-tax dollars, have more favorable tax treatment since a portion of each payment will be considered a non-taxable return of principal. By contrast, with a GLWB, earnings on the investment will be considered to be withdrawn before any return of principal, and withdrawals will be fully taxed until all earnings have been recovered.