Often overlooked by advisors and boomer clients who are deciding whether to purchase an optional rider for a deferred variable annuity is the enhanced death benefit the add-on can provide to beneficiaries. Those concerned about the financial well-being of the next generation, experts tell National Underwriter, would do well to take notice.
Consider, for example, a guaranteed living benefit rider that locks the contract value to a “high water mark,” or the highest cash value achieved by a certain policy anniversary. If an annuity in which the client has invested $100,000 later rises in value to $150,000, then dips to $125,000 two years later when the client passes away, the death benefit will be fixed at $150,000.
Clients might also opt for a return of principal rider. If the client deposits $200,000 and the stock market drops to $100,000, the benefit going to the beneficiary will be the original investment, minus withdrawals. Also available at added cost is a rider that increases the account value by a given percentage annually, such as a 5%, subject to a 200% cap.
Ethan Young, manager of annuity research at Commonwealth Financial Network, Waltham, Mass., says this “step-up” option may appeal to many boomers nearing retirement, but may not be suitable for younger boomers who are likely to experience more than a 200% market gain in their account value. He notes also that GLB riders, while boosting potential payouts for heirs, are more often than not purchased for the benefit of the annuity investor.
“With guaranteed living benefits, clients are more willing to use an annuity for what it was originally intended, which is to provide an income stream you can’t outlive,” says Young. “Because they’re paying for the rider, clients are more likely to spend down the annuity’s assets, leaving little or nothing for heirs. Also, some contracts will eliminate the death benefit because of their design.”
To illustrate, Young points to contracts wherein withdrawals reduce the death benefit proportionally (i.e., by the percentage the withdrawal represents of the cash value). When the death benefit exceeds the current cash value, as is typical in a down market, the proportional reduction methods yields a lower death benefit than does the dollar-for-dollar reduction method, which simply reduces the death benefit by the amount of the withdrawal.
Assuming an initial investment of $300,000 in a contract subject to the proportional method, if the client withdraws $50,000 annually for 4 years and then dies, the contract could actually yield a zero death benefit, as opposed to $100,000 under the dollar-for-dollar method. Many contracts that incorporate a GLB rider, notes Young, use the proportional reduction technique to help fund the optional living benefit.
“The difference between the dollar-for-dollar and proportional methods is not often explained to clients,” says Young. “And I doubt whether many advisors even know about the two techniques.”