Toronto – Guaranteed living benefit riders in variable annuities, so widely available in the U.S., are now steadily being integrated into Canadian products, known as segregated funds, says John Huggard in prepared remarks here for the Million Dollar Round Table’s annual meeting. A certified financial planner attorney in Raleigh, N.C., Huggard sees the evolution of Canadian segregated funds as very similar to that of VAs in the United States. By understanding the U.S. developments, “one can predict with some accuracy the future evolution of segregated funds in Canada,” he maintains. He sees the Canadian products developing along the very same lines as those in the U.S. Longevity and the sequence of returns on one’s investments are among concerns that individuals face when planning for retirement, notes Huggard, who is a senior member of the Raleigh-based Huggard, Obiol and Blake PLLC law firm The first concern, longevity, deals with whether the retiree’s assets will be sufficient, if properly invested, to last until retirement, he explains in his remarks.
The sequence-of-return issue raises the question of how the retiree’s nest egg will fare if the stock market decreases as a person enters retirement, he indicates. Using a hypothetical example, Huggard observes that 2 portfolios subject to the same parameters–an initial investment of $1 million, an average 7% return over the same period, and an annual withdrawal of 7.5%–can yield substantially different results. The portfolio with higher returns in the early years provides the client with income to age 95, whereas the investment that yields higher returns in later years runs out at 82. Those planning for retirement typically have their money allocated to one or more of 6 financial vehicles, says Huggard. These include a defined benefit (or pension) plan, self-funded retirement, non-qualified nest eggs (such as stocks, and mutual funds); non-qualified bonds, non-qualified fixed accounts (including money market funds and bank certificates of deposit), and real estate investments. “Today, variable annuities with living benefits can provide all of the benefits of [these] 6 asset classes,” says Huggard. “And [VAs] often eliminate the negative aspects of these same asset classes.” Among the product advantages he cites: a guaranteed minimum income for life of at least 5%, spousal protection, reduced stock market risk and no Social Security offset. Still other benefits include income payouts that can ratchet up in a rising stock market, inflation and principal protection through equity investing, a death benefit, tax-deferral and, with respect to qualified accounts, creditor protection.
The 3 major VA living benefit riders marketed in the U.S., says Huggard, include a guaranteed minimum accumulation benefit, a guaranteed minimum income benefit and a guaranteed minimum withdrawal benefit. The GMAB rider, when added to a VA or segregated fund, provides a money-back guarantee at maturity. The rider allows the client to invest in stocks and/or bond subaccounts for a period of years (usually 10 to 15). At the end of the investment period, the owner gets to keep all of the gain (less the costs of investing). If the owner’s account value declines at the end of an investment holding period, the issuing company will refund 100% of the investor’s original investment, notes Huggard. The GMIB rider, which Huggard notes is not offered in Canada, generally has a 10-year holding period. At the end of this period the investor is entitled to all of the gain if the stock market rises (less any costs of investing), plus a stream of income that will be paid to the owner for life if the stock market goes down. “These payments guarantee that annuity holders or their families will recover at least their initial investment in 8 to 10 years once payments start,” says Huggard. “After this period, payments continue for life or a minimum number of years, whichever is longer.” To obtain a lifetime stream of income, he adds, VA owners must annuitize the product. That means irrevocably surrendering the account value in exchange for a stream of income provided by the insurer. The GMWB for life feature lets individuals who are past a certain age invest in stocks and bonds to receive at least 5% of the amount invested each year (based on the individual’s age) for the rest of their lives, even if the stock and bond markets decline over time, Huggard says. If the stock and bond markets go up, he continues, the 5% annual income stream can increase but not decrease. Account holders may also be able to leave a significant death benefit or continue to provide a lifetime stream of income to their spouse or family should they die before life expectancy. If withdrawals are not made immediately, the account value ratchets or resets at a fixed rate of return on which future withdrawals are based. Holders of VAs that carry a GBWB for life rider, do not need to annuitize the product, Huggard says. An owner can secure the annuity’s cash surrender value, provided the rider may be liquidated at any time.
Huggard points to 3 hypothetical individuals–Margaret, Sam and Sara–to illustrate where the guaranteed living benefit riders are most appropriate. Case 1: Margaret is 55 years old and has $350,000 to invest for the next 10 years. She desires an investment that will allow her to be in the equities markets but she requires that:
o The entire $350,000 go to work for her without a reduction in upfront costs or expenses;
o The investment be held predominately in equities;
o She receive professional financial advice on the investment for the next 10 years without cost.
o The investment not have an annual cost that would be inconsistent with a typical equity investment of $350,000.
o When she withdraws her money from this investment, she is able to keep all of her gain, less her investment costs.
o At the end of 10 years, should Margaret’s account value be less than the $350,000 she originally invested, she wants the financial institution involved to return all of her $350,000 investment without making any charges.
Given these requirements, says Huggard, Margaret should consider a VA or segregated fund carrying a GMAB rider. Case 2: Sam is 59 and is 10 years away from retirement. He wants to invest a $500,000 in an investment that Huggard says will give him the following benefits:
o Sam wants his investments to be held predominately in the equity markets;
o If the account goes up dramatically over the next ten years, he wants to be able to close the account and withdraw the funds;
o Should the market go down significantly over the next ten years, he wants a guarantee that in ten years he will receive a check for $62,500 a year for the rest of his life, guaranteed for a minimum of twenty years. Should the stock market spike during this ten year investment period, Sam wants his lifetime payments based on the higher spiking value of the market rather than the base value).
In this situation, a VA with the GMIB rider should be considered, says Huggard, but he points out that this rider is not available in Canada. Case 3: Sara is 65 years old and a recent widow. She has $700,000 to last her for the rest of her life. She wants an equity-based investment that will guarantee her a minimum of $35,000 a year starting immediately with a chance for that income to increase (but not decrease) should the stock market move up. Sara, also wants to know that:
o Her stream of income will last for her entire lifetime, even if she should live to well over age 100;
o If she dies prematurely, any remaining account value will be paid out to beneficiaries;
o She won’t have to annuitize;
o She has the option to withdraw against the account balance at any time.
For Sara’s $700,000 investment, Huggard recommends a VA with the GMWB for life option.