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Annuities: The Guaranteed Minimum Income Benefit

Aug 17, 2007
Variable Annuities now offer a Guaranteed Minimum Withdrawal Benefit which allows you to earn 5% or 6% even if the market drops significantly. Undoubtedly, you will be pitched a variable annuity or pressured to transfer your existing one into a new contract with this benefit. Should you? Read on to uncover the truth behind this feature and see if it's right for you.

The Guaranteed Minimum Withdrawal Benefit provides a guaranteed minimum return on the annuity contract that can be accessed prior to death. For instance, the GMWB rider might guarantee a minimum return of 6% per year. So even if the market value of the account drops and doesn't recover you will still be guaranteed of earning 6%.

Most people who owned a variable annuity between 2000 and 2002 quickly regretted the purchase. They were stunned to see their account values drop significantly. Sure, the variable annuity has a death benefit but that doesn't help you fund your lifestyle while you're alive.

As a result, the sales of variable annuities have declined over the last few years. In fact, the majority of variable annuity sales the last few years have simply been from people moving money from one annuity contract to another. Insurance companies had to find a way to attract new investors. They think the Guaranteed Minimum Withdrawal Benefit will do that.

Should you buy one or switch your existing annuity to one with this new benefit? Not in my opinion. Here's why.

It's too long-term. To take advantage of this benefit you have to keep your money tied up even longer. The GMWB isn't immediately active. In most contracts, money must be invested for ten years before you can take advantage of it. Usually, you then must annuitize the contract for a minimum of five years in order to receive those benefits. This means you are looking at a minimum of a 15 year investment. By the way, you lose the GMWB benefit on any money you withdraw prior to the initial 10-year waiting period.

It increases your costs even more. The additional charges for the GMWB can be 1/4% of 1% or more every year. And you pay the additional annual fee on the full account balance regardless of whether you ever use the benefit.

That's in addition to the 1.5% per year charge for administrative and mortality expense fees. That's in addition to the management fees of 1%-1.5% paid to the people running the sub-accounts. All in all, you could be facing annual fees of 3.5% per year or more!

There is a low probability of needing it. The insurance companies know history. The lowest 10-year period on the S&P 500 since 1975 was 5.8%. Eighty-two percent of that time, the S&P 500 delivered average gains over 10% ! There is a very low probability of this benefit ever being used.

The expense of this benefit will have produced a drag on performance each and every year. Over a ten-year period, your account value could be 20-30% less in a variable annuity with this benefit then in a low-cost exchange-traded fund. If you average 6.1% in the variable annuity over 10 years then all you were paying for was a false sense of security.

It distracts you from why you invest in the first place. People use stock market-based investments to generate a higher return than on other investments. You invest for performance. The reason variable annuity sales have declined the last several years is because of poor performance.

I've never heard anyone say they chose to invest in a variable annuity because it had better performance than the alternatives! Don't let pricey gimmicks distract you from the fact that you are making a stock market-based investment. Would you invest in a mutual fund that charged 3.5% a year in fees when there were others available that charged much less? That's essentially what you are doing when you buy a variable annuity.

So beware of the advisor that recommends you buy a variable annuity. A properly managed, well diversified portfolio is a much better choice. It may not be flashy, but it works--while allowing you to maintain control and flexibility over your money.
About the Author
Nationally-syndicated financial columnist and Certified Financial Planner Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He will answer your financial question FREE at http://www.guardingyourwealth.net/
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