In this post, the second in our series of blogs on what advisors need to know about variable annuities, we will examine the mechanics of the Guaranteed Lifetime Withdrawal Benefit (GLWB).
In a variable annuity with a GLWB, the underlying account grows each year based on the performance of the account’s investment portfolio net of withdrawals and fees. The highest account value attained is saved and this becomes the high-water mark for all future periods.
Withdrawals begin by taking the withdrawal percentage specified by the contract (5 percent, for example) and multiplying that figure by the high-water mark. The withdrawal amount, along with fees, is subtracted from the actual account value, and the returns of the underlying portfolio are added to calculate the new actual account value.
If the new actual account value is greater than the old high-water mark, then the new high-water mark is set to the new actual account value. If not, then the high-water mark remains the same.
Payments are calculated and made via the above mechanism until the actual account value goes to zero or the investor dies. If the actual account value goes to zero, then the insurance company steps in and continues making the annual payments for the life of the contract. If the investor dies, the remaining actual account value is paid as a death benefit.
The following graphs show sample calculation of payments, actual account value and high-water mark for a VA with a 5percent GLWB where withdrawals begin immediately. The example begins with an initial investment of $100,000, has fees of 3 percent and a portfolio return of 5 percent a year.
The first two graphs show the gap between the actual account value, and the high-water mark starts for the first and second year once withdrawal benefits are taken.
Calculation for the first year with a return of 5 percent on the underlying portfolio:
Calculation for the second year with a return of 5 percent on the underlying portfolio:
The third graph shows 10 years of the calculation with each year having a 5 percent return on the underlying portfolio:
The fourth graph shows the full 10-year example, but with an annual portfolio return of 8 percent.