Variable Annuities with Living Benefits
Annuities of all kinds are popular with baby boomers who have turned gun-shy about the stock market. Annuity products make a lot of money in fees and commissions for the insurance companies that sell them. This means that there are a lot of marketing and advertising resources devoted to attracting baby boomers who are eager to put their dwindling retirement funds into something perceived as safe.
One example is the equity indexed annuity (EIA) which has characteristics of both fixed and traditional variable annuities. Typically, the returns from the EIA are tied to the stock market but with some minimum floor or payback offered.
Other sellers of variable annuities are promoting new “living benefit” features that guarantee certain payouts for life or other lifetime benefit, regardless of what happens in the stock market. That has been one of the biggest complaints about variable annuities. Annuities with guaranteed living benefits (GLB) come in different flavors. One flavor is a “guaranteed minimum income benefit” which guarantees that the owner will receive a minimum income stream starting at particular future point in time.
A second type of annuity living benefit is the “guaranteed minimum accumulation benefit.” In this version, the insurance company guarantees that the account will have a minimum value at a certain point in the future.
A third type of annuity living benefit is the “guaranteed minimum withdrawal benefit.” In this variation, there is a guaranteed income benefit, but it does not require annuitizing. (“Annuitizing” is the process of converting an annuity from being a cash accumulation product into one that provides a guaranteed or variable payout.)
Finally, there is the “guaranteed-for-life income benefit.” With this form of annuity life benefit, income withdrawals start and last until the cash value of the annuity reaches zero. At that point the withdrawals stop. Annuitization then occurs on a guaranteed benefit for life, the amount of which is not determined until the time of annuitization.
So the question now is whether buying a variable annuity with a living benefit is a smart option? Scott Burns, one of my favorite personal finance writers, says no.
To appreciate Scott’s analysis and views on variable annuities, consider that in many cases, adding a living benefit to a variable annuity can increase the annual cost of the annuity to as high as 3% of the value. That is huge. The other problem is that the cost of purchasing a variable annuity with living benefits can be substantially higher than buying a life annuity with the same monthly benefit.
This is what Scott Burns wrote about this comparison:
The purchase of a $100,000 variable annuity contract with such a guarantee means a 65-year-old man can have an income of $5,000 a year, or $417 a month for life, from his investment. He will get this regardless of what happens to the market. He might even get more if his account can rise over the burden of 3 percent in expenses and $5,000 annual withdrawals.
According to www.immediateannuities.com, the same 65-year-old man can buy a life annuity that will pay $417 a month for life for about $61,000. That means he’d have $39,000 “left over” to invest for more income later.
I have to agree with Scott on this. If you want to make an annuity part of your retirement income plan for the monthly payout, it makes a lot more sense to do it with a life annuity. The living benefit feature with a variable annuity is attractive but is just too expensive.
Photo credit: GarySmith70
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Although I am a bit leery of the fees associated with variable annuities, the article does not present a fair apples-to-apples comparison between immediate annuities and variable annuities.
Immediate annuities are just that. Payments begin immediately, and the annuitant loses control of their money. Payments are fixed for life (unless a rider is added).
Variable annuities are meant to be a long-term investment, and should be sold as such. So, the comparison listed above by Scott Burns is not a fair one, as the two products have two different objectives. If a person purchases a variable annuity and waits ten years to begin 5% withdrawals, their monthly payout would be significantly higher than the $417 in the comparison.
The bottom line, if income is needed immediately, than the immediate annuity is the way to go. If a person has time to let their money grow, then a variable annuity with living benefits is a good way to go.
Scott’s advice, although well intentioned, is just plain poor. The VA’s with the Guaranteed Income Benefit, if truly understood, irrespective of the fees, have Guaranteed ‘Set Points’ that guarantee an amount for income purposes, and that ‘set point’ can never fall below it’s original point; witness the market fall of 2008.
Yes, Scott makes a good point about an immediate annuity. However, what if an individual had their money in the market, lost principal, then went out to purchase an immediate annuity? So what? Scott loses sight of that very important point.
To fully understand all the ‘finer points’ of these contracts would take more than this space allows, and certainly there are some “gotchas” in these new VA’s, but to say they are not appropriate, is giving poor advice. They are not appropriate for everyone, and certainly useful for some.