Guaranteed Lifetime Income Benefits – Part 1: A Primer
By Jonathan C. Illig, Brokers Alliance
Guaranteed Lifetime Income Benefits are extremely popular and useful; here is a primer on how they work and how to explain them.
As the “boomer” retirement wave is accelerating, the popularity of Guaranteed Lifetime Income Benefit (GLIB, also known as Guaranteed Lifetime Withdrawal Benefit, or GLWB) riders with Deferred Annuities is also accelerating. Some studies cite the inclusion of GLWB on as much as 80% of the deferred annuities sold in the independent advisor marketplace. Yet many annuity and financial professionals remain unclear as to how these benefits work, and how to best and accurately explain them to their clients. In doing so, this Author will use the most commonly-used terms for GLIB and deferred annuity components, but please bear in mind that some insurance carriers use somewhat different terms or descriptions.
Let’s begin with why an annuity client might want or need a GLIB. All deferred annuities, without an additional rider, provide “income benefits” in two forms; through the annual penalty-free withdrawal provision, and through the option to annuitize the contract to create a lifetime (or period certain) income stream. In many client situations, these features may be ??either sufficient ??or desirable. For example, when using penalty-free withdrawals to provide retirement income, the principal and interest may not be sufficient to last for the clients’ lifetime; they run the risk of outliving their money. This risk can be alleviated without a GLIB rider by annuitizing the contract for a lifetime payout, but this option may not provide sufficient income, and it is unattractive to many because they trade control of their money (Account Value) for the lifetime income stream; people like to keep their arms around their money. The GLIB can provide a solution for both situations. The core benefit of a GLIB - and therefore their popularity - is that it will provide a guaranteed lifetime income stream in the form of a systematic withdrawal, while at the same time keeping the owner in control of their Account Value (cash), because the benefit is not an annuitization, rather it is a systematic withdrawal.
Deferral Period Growth
When a GLIB rider is opted, prior to the start of the lifetime income benefit the annuity will track two separate values, and they are as different as “apples and oranges:”
- The Account Value: This is the “cash value” of the annuity at any given time (less early withdrawal charges). The Account Value is money to which the client has access.
- The Income Base Value: This is a separate value used only to determine the dollar amount of the lifetime income withdrawal when triggered. The Income Base is only a math formula, it is not money.
During the deferral period, that is the time before the client triggers the lifetime income benefit, both the Account Value and the Income Base will grow in value, but do so differently in most designs:
- Account Value Growth: The Account Value grows based upon credited interest, be that indexed interest, guaranteed interest, or annually-declared interest. Simply put, the Account Value will function exactly as it would without a GLIB rider (except GLIB fees will be deducted from it, more on that later).
- Income Base Growth: The Income Base will typically grow using a guaranteed method, and there are several different methods currently available.
- The Common Method. The most commonly-used method for growth of the Income Base will be at an annual guaranteed rate, colloquially referred to as the “roll-up rate.” This rate may be compounded annually, or be “simple” (non-compounded), and typically increases the Income Base for a specified period of years (i.e. 10 years), or until the Owner triggers the lifetime income benefit, whichever occurs first.
- Other Methods. Increasingly, insurance carriers are using alternative methods of increasing the Income Base. For example, one leading carrier grows the Income Base using a series of percentage boosts every other year (i.e. 20%, 15%, 15%), while others have moved to not revealing the “math formula” that increases the Income Base, and simply showing the actual dollar amount of the lifetime income withdrawal. Some carriers don’t actually guarantee any increase at all, but instead guarantee Income Base growth only as a multiple of credited interest earnings (i.e. 150%). In the marketplace, there are also versions that combine both truly guaranteed and interest-earnings multiples for Income Base growth (with the popularity of these benefits, most innovation in design is being focused upon GLIB benefits).
IMPORTANT: The guaranteed (or non-guaranteed as is the case with some contracts) growth of the Income Base is not a guarantee of interest crediting or growth of the Account Value. As previously stated, Income Base growth is a math formula, it is not money. This is easily misunderstood by clients, so the annuity professional must take care to ensure that the client understands this important difference. In fact, client confusion on this point (and frankly, intentional obfuscation by less-than-honest agents) is one of the reasons why many insurance carriers are moving to not revealing the “math formula,” or using large percentage “boosts” so as to reduce the likelihood that clients will confuse guaranteed growth of the Income Base with growth of the Account Value.
Commencing the Lifetime Income Benefit
When the Owner triggers the Lifetime Income Benefit, the dollar amount of the systematic withdrawal is determined by the Income Base Value (or Account Value if higher, but that would be rare) and the Income Benefit factor applicable to their attained age.
As example, assume that $100,000 premium was positioned to a deferred annuity with a GLIB rider, at issue age 60.
The client, now age 70, triggers the benefit. The Income Base has grown to $180,000, and the Income Benefit Factor corresponding to age 70, single life, is 5.50%. The lifetime withdrawal is determined by multiplying the Income Base Value by the Income Benefit Factor, producing a lifetime income withdrawal of $9,900 annually (180,000 x 5.5% = 9,900). If the client is married and wanted joint life income, the factor corresponding to the younger of the couple would be used instead of the single life factor.
After Lifetime Benefit is Commenced
Once the lifetime income withdrawal is commenced, in most contracts the Income Base Value stops growing, and will decline at the same rate as the withdrawals (remember, the Income Base is a math formula, and it has fulfilled its purpose now). The withdrawals are deducted from the Account Value, and the Account Value continues to grow based upon credited interest, net of the withdrawals.
Over time, and particularly if the Owner lives a long time, the lifetime income withdrawals may deplete the Account Value (how quickly this happens depends upon interest crediting to the Account Value relative to the amount of the lifetime withdrawal). This is where the GLIB benefit really shines - if the Account Value is depleted, the Owner is guaranteed the amount of the GLIB withdrawal for their remaining lifetime (or joint lifetimes), no matter how long they may live (assuming that the Account Value is not depleted due to withdrawals in excess of the GLIB amount).
You can think of this as a “secondary guarantee,” with the “primary guarantee” being the core loss protection of the base annuity contract.
This is how a GLIB provides the retiree with lifetime guaranteed income while retaining Account Value control and access. Rather than trading their savings for an annuitized income stream, they get a lifetime income stream and Account Value access. Let’s discuss that next.
Account Value Access Before and After Lifetime Income
As previously mentioned, the key differentiator between using GLIB for lifetime income versus annuitization is that the client has continued access to their Account Value (their money). Both before commencing GLIB income, and after commencing GLIB income, the Owner can withdraw money under the penalty-free withdrawal provision from their Account Value, but doing so will reduce the amount of the GLIB income. In most contracts, a withdrawal prior to starting lifetime guaranteed income withdrawals will result in a proportionate reduction of the Income Base Value. In simple terms, this means that a withdrawal of 10% of the Account Value will reduce the Income Base Value by 10%, with the resultant effect of reducing the future dollar amount of the lifetime income withdrawal produced by the Income Base Value. Similarly, in most contracts, after lifetime withdrawals have started, the Owner can withdraw more than the amount of the dollar amount guaranteed by the rider; this will reduce the amount of subsequent lifetime income withdrawals, again typically on a proportionate basis (in some contracts, withdrawals either before or after lifetime income has begun will reduce the Income Base on a “dollar for dollar” basis instead of a proportional basis). Therefore, the ability to access the Account Value, especially after the start of the guaranteed lifetime income, should be viewed as “emergency access only” from the standpoint of the client; after lifetime income benefits are started, if the Account Value is depleted due to withdrawals in excess of the GLIB amount, the lifetime guarantee is negated.
A Word About Fees
The vast majority of deferred annuities that offer a GLIB rider charge an annual fee for the benefit. One can view this fee as the cost of transferring the income longevity risk to the insurer. Most commonly, the fee is based upon the Income Base Value, and deducted annually from the Account Value (although some base the fee upon the Account Value); thus the dollar amount of the fee will increase as the Income Base Value grows. The annuity professional, and especially the client, must clearly understand that while the base contract cannot decline based upon financial market volatility, it is possible for the Account Value to decrease due to the GLIB fee. Most GLIB are associated with Fixed Indexed Annuities, so there will be periods when there is no indexed interest credited if the market index performance is negative, but the GLIB fee is imposed. This potential decline in Account Value can be mitigated by allocating some of the clients’ premium to the fixed interest strategy within the base contract.
Jonathan C. Illig, Executive Sales Consultant at Brokers Alliance, is an 18 year veteran in annuity sales and support.
Jon may be reached at [email protected].
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