Annuity FYI Overview
Variable annuities come with a host of optional features that you can select for an additional annual fee. One increasingly popular type of variable annuity feature is the lifetime income benefit provision (LIB).
The concept behind a Lifetime Income Benefit is simple. If you purchase a Lifetime Income Benefit Rider with your variable annuity, the insurance company guarantees a regular monthly, quarterly, or annual payment for your lifetime, even if your account balance goes to zero. For example, suppose you invest $100,000 in an annuity with a 5 percent lifetime income benefit rider. The insurance company guarantees that you can withdraw $5,000 per year for the rest of your life, even if your account balance is zero. In such a case, the insurance company uses its own money to pay you, until you die. An LWB assures you that you will never outlive your assets. As such, LIBs are most suited for investors who plan on a lengthy retirement (say, thirty years or more), and the piece of mind of regular, guaranteed income.
How Are LWBs Different From GMWBs?
You may be wondering how LIBs are different from Guaranteed Minimum Withdrawal Benefits (GMWBs). GMWBs also give you a guaranteed monthly, quarterly, or annual income, but only until the insurance company has paid you back an amount equal to your principal, account value, or until the end of the contract term. Unlike LIBs, GMWBs do not guarantee a lifetime of income.
In addition to guaranteeing lifetime income, LIBs typically allow you to base the withdrawal percentage on some minimum compounded growth rate (such as 5%). If your account value appreciates, you typically have the option of locking in the increased account value on a contract anniversary — or “stepping up” the amount on which the withdrawal percentage is based.
Let’s look at some examples to understand how it works. For each example, assume a $200,000 investment in an LWB with a guaranteed minimum growth rate of 5%, regardless of market performance.
Example #1
First, let’s take a case where the market performs poorly during the course of your investment. Five years after you purchase the annuity with the LIB rider, you want to retire and start taking withdrawals, but the market has declined significantly and your account value has dropped to $150,000. Because of the guaranteed minimum growth rate, however, you can base your withdrawal on $255,000 — 5% annual compounded growth on your $200,000 for the past five years. At a 5% annual withdrawal rate, this would give you over $12,000 per year for the rest of your life, regardless of future market performance.
Example #2
Now let’s take a case where the market performs well during the course of your investment -- fifteen years later you want to retire and start taking withdrawals, and your account value is $427,000, far greater than the guaranteed minimum 5%. At this time you could start taking withdrawals, and realize 5% of $427,000, or over $21,000 per year for the rest of your life, regardless of future market performance.
Example #3
Finally, suppose seven years into your investment your account value has grown to $338,000. At year ten you want to retire and start taking withdrawals, but your account value has gone down since year seven to $275,000. Some insurance companies allow you to "step-up" the guarantee from your initial principal to an amount to which it has grown. In this case at year ten you could “step-up” the account value to its ten-year high of $338,000, and take over $16,000 annually for the rest of your life, regardless of future market performance.
Considerations in Purchasing a Lifetime Income Benefit Rider
Guaranteed Minimum Growth Rate: LIBs typically allow you to base the withdrawal percentage on some minimum compounded growth rate (such as 5%).
Maximum Withdrawal Amount: Make sure that the LIB’s maximum withdrawal amount is consistent with your income needs. Most LIBs allow you to withdraw between 5% and 7% annually, although some offer as high as a 12% withdrawal.
Step-Up: As discussed in Example #3 above, a step-up is an important feature of an LIB when your account value increases. Make sure it is a feature of the LIB that you purchase.
Fees: Fees for the LIBs range from 0.25% to 1.00% annually. That said, a lower fee does not always mean a better LIB -- consider the LIB fee as well as the step-up, maximum withdrawal percentage, as well as other fees associated with the annuity, such as M&E and sub-account expenses. Maximum Withdrawal Amount: Make sure that the LIB’s maximum withdrawal amount is consistent with your income needs. Most LIBs allow you to withdraw between 5% and 7% annually, although some offer as high as a 12% withdrawal.