Do You Understand How a GMIB Works?
Is it a big surprise to me that the average investor does not understand how their variable annuity benefits work? No, I wish it was. It is for this reason I launched annuityiq.com. The fact that few people truly understand their variable annuity benefits is absolutely believable.
These benefits are sold as a, “don’t worry if it does not work out you will at the minimum get your 5 to 7% rate of return.” The rate of return with a GMIB, guaranteed minimum income assistance, builds totally separate from your actual account value. Your investments will fluctuate and be completely dependent upon the sub-accounts performance. A sub-account is the insurance companies name for a mutual fund, but they cannot call a sub-account a mutual fund.
The GMIB will grow in a separate phantom bucket called your “assistance base”. Your initial assistance base is simply the amount of your initial investment, also known as your buy premium. The base assistance is what the 5 to 7% will compound on. You have to understand that this is and has no relation to your cash value or market value of your contract.
A GMIB will have a holding period attached to it. The holding period is the minimum number of years that you have to keep up the contract before you can exercise the assistance. This waiting period can vary from 7 years to 10 years depending on the insurance issuer’s terms. When you exercise the assistance you are annuitizing it and will receive a lifetime of income.
The annuitization tables that are used are based on very conservative assumptions. The insurance company usually guarantees you a minimum interest rate, about 2%, and fall outside of traditional annuitization tables. The company may roll back your age to calculate your annuity payments. This age rollback is not good for you. The company will generally roll your age back anywhere from 8 to 10 years. This method that if you exercise this assistance when you are 75, the company will base your payments as if you were 65 years old.
The end consequence is you receive lower annuity payments. Also the only way to take these annuitized payments is period certain with life. Lifetime payments are lower than period certain payments. Period certain payments range from 5 years to 20 years and are geared to pay you all of your interest and principal back over in any case time frame you had chosen. For example if you chose a 10 year period certain then at the end of 10 years you will not receive anymore payments. The life with period certain is basically a life time assistance and if you die prior to the period certain time then a beneficiary will receive some payments until that period certain is up.
With living benefits, specifically GMIB’s, you have two flavors to choose from.
The difference between the two is major. Dollar-for-dollar will allow you to withdrawal up to the GMIB interest rate amount without impacting your base assistance.
A $100,000 investment with a GMIB of 5%, which is dollar-for-dollar; you could withdraw that 5% without decreasing your assistance base of $100,000. You could, if your investments did not perform, annuitize the original $100,000 after 10 years, already if your account’s cash value is almost depleted. This assistance is good during a declining market.
Proportionate withdrawals will reduce your base assistance by the same percentage as the withdrawal. So you could not take out that 5% compounding without reducing your base assistance. The only time you could take income out is if the market, or your investments, did well. This is because you are taking the 5% out of your earnings and consequently you will not impact your base assistance. The only time this assistance is good is when the market, or your investments, go up in value.
I know it is terribly complicate to understand exactly how these benefits work. The good news is most of the GMIB’s are dollar-for-dollar now, there are only a few that are proportionate. You have to read either the prospectus or the contract to find out if the GMIB is dollar-for-dollar or proportionate. You also need to realize that already if your contract is dollar-for-dollar any withdrawal over the GMIB interest rate will be proportionate and will impact your base assistance.
The question is now why would anyone want a GMIB? I can easily answer that question. People want peace of mind and the comfort so already if everything went wrong I nevertheless have this to rely upon. I do think that people do not understand how these benefits work and have bought them under a misunderstanding of information. These benefits can be so difficult to explain that some people summarize it way too much and that leads to the misunderstanding.
I, personally, feel that these GMIB’s are old news. I do not, nor have I ever, fully liked them. Like I said before they are difficult to understand and can rule to problems later in life. I also do not like the idea that you have to annuitize to realize the assistance. With the arrival of For-Life benefits why would anyone want a product that is so restrictive? I do not believe they are anymore.
I view the folks who solely sell GMIB benefits as the last horse and buggy salesmen. They either do not like the For-Life benefits or are hung up on being able to offer “6%” GMIB’s. Most For-Life benefits are 5% and are consequently less attractive compared to offering 6% or already 7% in some situations.
The bottom line is this; For-Life is the way to go. You have flexibility, the possible for higher income if your investments do well, no annuitization and your money is guaranteed for life. Compared to a GMIB which may be capped as it reaches certain compounding thresholds, you have to annuitize it to realize the assistance, you have to wait ten years to exercise the assistance and you have to be careful about how much money you take out of your investment.
There are too many caveats to GMIB’s and not enough reward. A For-Life assistance gives you everything you could ask for out of a variable annuity. The question is how are you going to find the best For-Life assistance? I did the research for you, use it, get “The Annuity Report” at http://www.annuityiq.com.