Annuity: Choices Abound for Today’s Retiree
Variable annuities are getting another look thanks to the growing population of retirees and their interest in lifetime retirement income and living benefit options. Yet when considering the purchase of a variable annuity, it is crucial that individuals understand the product’s features and their associated fees.
As the earliest baby boomers begin to enter retirement, the various income guarantees and other living benefits offered through variable annuities (VAs) are gaining in importance.
Yet before you rush to add a VA to your retirement funding scheme, take some time to understand what VAs have to offer in a general sense and to sort through the host of optional features and their associated fees and investment risks.
Variable Annuities — A Brief Primer
The Securities and Exchange Commission defines a VA as “a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date.”1 You can purchase a VA by making a single purchase payment or a series of payments spread out over a period of time.
The “variable” modifier denotes that the value of your VA will vary depending on the performance of the underlying investments you choose when contributing to and managing your account. Most VAs offer a menu of subaccounts that, similar to defined contribution plan options, invest in different styles of stocks, bonds, and money market instruments.2 Therefore, VAs could lose value.
VAs are used mainly to supplement more traditional sources of retirement income such as Social Security and pension plans. Common features include:
- Tax-deferred growth. You will pay no taxes on the earnings from your annuity investments until you begin making withdrawals or receiving periodic payments.3
- Unlimited contributions. Generally speaking, there is no limit to the amount of money you can put into a VA.
- No mandatory withdrawals. If your VA is not part of an IRA or a qualified retirement plan, you are not required to begin taking minimum distributions after age 70½.4,5
- Death benefit. If you die prior to annuitizing your contract — that is, converting your VA into regular income payments — your beneficiary will receive, in general, an amount at least as much as you contributed in payments, less any withdrawals.
- Lifetime income benefits. Annuity holders typically have several options for receiving annuity payments for the rest of your life, including the choice of continuing payments to beneficiaries for a set period of time.
Living Benefit Options — Driving Today’s Annuity Market
Although the distinguishing characteristic of an annuity is a stream of income that cannot be outlived, most VAs offer — for an additional fee — optional principal protection benefits. Referred to collectively as living benefits, they offer exposure to the market’s upside while protecting against the effects of market declines on your account value or future income. In some cases, a combination of these optional benefits may make some variable annuities a potential rollover vehicle.6
There are three basic types of living benefits.
- Guaranteed lifetime withdrawal benefit (GLWB). This benefit guarantees a return of your purchase payments (less prior withdrawals) through annual withdrawals for a specified period or for life.
- Guaranteed minimum income benefit (GMIB). This benefit guarantees a minimum future income level regardless of how the market performs.
- Guaranteed minimum accumulation benefit (GMAB). This benefit ensures that you retain the value of your purchase payments regardless of investment performance.
|Living Benefit Basics|
|Guaranteed Lifetime Withdrawal Benefit (GLWB)||Guaranteed Minimum Income Benefit (GMIB)||Guaranteed Minimum Accumulation Benefit (GMAB)|
|Benefit calculation||Payout is either a pre-set percentage of your net purchase payments (and any applicable step-ups), typically around 4% per year, or is based on life expectancy||Payout is based on the greater of your account value or your net purchase payments (and any applicable step-ups) at the time you annuitize||If your contract value is worth less than your net purchase payments (and any applicable step-ups) on a pre-set date, the insurer will make up the difference|
|Annuitization||Not required||Long term, typically 10 years||Long term, typically 10 years|
|Duration of benefit||Lifetime payments, if withdrawals stay within prescribed parameters||Lifetime income guarantee||One-time, yet can be renewed|
|Potential uses||Investors who seek equity exposure for growth potential, but also have a need for liquidity in the short term||Investors who seek long-term growth potential, have no immediate need for liquidity, but want to guarantee a future stream of income||Investors who seek long-term exposure to the market’s upside potential as well as principal protection and/or minimum future income|
In practice, living benefits have evolved increasingly into new hybrid benefit options, offering a mix of guarantees and participation in the market’s potential upside, as insurance companies seek ways to differentiate their offerings in the marketplace. This environment of expanding flexibility and functionality is helping to redefine VAs for a new generation of retirement investors. But with added choice comes the possibility for confusion and the need for expert advice.