What it means
A variable annuity invests the saver's money in funds, so its value rises and falls with markets. A guaranteed minimum withdrawal benefit adds a promise on top of that.
The insurer agrees that the owner can take a fixed percentage of an agreed amount every year, even if poor markets reduce the account value to zero. The agreed amount is called the benefit base, and it is often equal to the original investment.
The percentage withdrawn each year is the withdrawal rate, commonly a few percent, and the insurer promises to keep paying until the total withdrawn equals the benefit base. This differs from a lifetime guarantee, which continues for as long as the person lives, and some products offer that instead.
The fee is the price of the safety net. It is usually a percentage of the benefit base or the account value each year, and it comes on top of the fund charges and basic insurance charges.
Over many years these costs can reduce the account's growth noticeably, so the guarantee is only worth buying if the protection is genuinely wanted. For advisers and clients, the main questions are whether the guarantee is needed, what it costs, and what rules apply.
Withdrawing more than the guaranteed amount usually reduces the benefit base, sometimes by more than the extra amount taken. Some contracts also limit the investment choices available, so that the insurer can control its own risk.
The guarantee is only as strong as the company that issues it. It is a promise made by the insurer, not a government guarantee, so the financial strength of the company matters.
Regulation and product features differ by country, and anyone considering one should get independent advice and read the contract carefully.
In practice
Real-world examples.
Example
A 62-year-old retiree is worried about a market fall just after she stops work. She buys an annuity with a GMWB and receives $10,000 a year on a $200,000 investment, which gives her confidence to spend steadily.
Example
A financial adviser compares an annuity with a GMWB with a straightforward investment fund. He shows the client that the guarantee costs $2,000 a year on $200,000, and helps the client decide whether the peace of mind is worth that amount.
Example
A client takes $15,000 in a year when the guaranteed amount is only $10,000. The excess withdrawal reduces her benefit base, so her future guaranteed income falls, a result she had not expected until her adviser explained the contract.
Formula
Calculation
Annual guaranteed withdrawal = Benefit base x Withdrawal rate
Years of guaranteed income = Benefit base / Annual guaranteed withdrawal
Annual rider fee = Rider fee rate x Benefit base
A retiree invests $200,000 in an annuity with a GMWB, so the benefit base is $200,000. The withdrawal rate is 5%, so the guaranteed annual withdrawal is $200,000 x 0.05 = $10,000. The guaranteed income lasts $200,000 / $10,000 = 20 years, even if the account value falls to zero. If the rider fee is 1% of the benefit base, the fee is $200,000 x 0.01 = $2,000 a year.Case study
Seen in the real world.
Cedarwood Financial Planning is an illustrative, fictional advisory firm. One of its clients, a retired teacher, put $300,000 into an annuity with a GMWB at a withdrawal rate of 5%, giving a guaranteed $15,000 a year.
In the first three years, markets fell sharply and the account value dropped to $190,000 even after withdrawals. The guaranteed income was unaffected, and the client was able to keep paying her household bills with confidence.
Cedarwood's finance team also reminded her that the fee of 1% of the benefit base, or $3,000 a year, continued regardless of performance. The illustrative lesson is that the guarantee provides certainty, and that certainty has a price that should be set out clearly from the start.
Watch out
Common mistakes.
- Believing the guaranteed benefit base is cash that can be withdrawn at once, when it is only the figure used to calculate the guaranteed income.
- Taking larger withdrawals than the guaranteed amount without checking how they affect the benefit base.
- Ignoring the annual fee, which reduces growth every year whether or not the guarantee is ever used.
Questions
People also ask.
Is a GMWB guaranteed for life?
Not necessarily, because a GMWB usually guarantees withdrawals until the benefit base has been paid back, whereas a lifetime version is a separate feature.
Who stands behind the guarantee?
The insurance company that issues the contract, so its financial strength is important.
Is a GMWB suitable for everyone?
No, it can suit people who want income certainty, but the fees may not be worth it for those who can tolerate market ups and downs.
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