White paper confuses GMWB and GLWB

A white paper that appeared in the Sept. 22 issue of InvestmentNews, "Delivering Consistent Retirement Income Results," by Noelle E. Fox and Drew A. Denning, is, on the whole, an excellent piece, both informative and well-written.

A white paper that appeared in the Sept. 22 issue of InvestmentNews, “Delivering Consistent Retirement Income Results,” by Noelle E. Fox and Drew A. Denning, is, on the whole, an excellent piece, both informative and well-written.

There are, however, a couple of errors.

In describing their second strategy, the authors referred to a guaranteed minimum withdrawal benefit rider on a variable annuity. They wrote that “by opting to receive income payments at a fixed percentage for life, a retiree is protected against outliving this particular income stream.”

This is a correct description of a guaranteed lifetime withdrawal benefit, which isn’t the same thing as a GMWB, the term that Ms. Fox and Mr. Denning used. The authors’ choice of wording is understandable, as some annuity issuers label their version of the GLWB as a GMWB with a “lifetime option.”

Moreover, some recent studies use the term “guaranteed minimum withdrawal benefit” and the acronym GMWB to describe riders guaranteeing lifetime income.

That isn’t correct.

The GMWB offered by most insurers does not guarantee payments for life but only until the “benefit base” falls to zero. What Ms. Fox and Mr. Denning described is the GLWB.

I mention this only because “guaranteed living benefits” are confusing enough without adding to the problem by using the wrong terminology

Ms. Fox and Mr. Denning correctly observed that the GLWB rider does not, at least in any version that I am aware of, offer an inflation-adjusted income.

They wrote that “annual fees can add up to more than 2.75%. Assuming inflation is 3%, the investment would have to earn a 5.75% return just to make up for the eroding impact of fees and inflation.”

That is correct. However, Ms. Fox and Mr. Denning then wrote that “in order to allow income to step up on a regular basis after withdrawals start, the annual return would need to be 10.75%, due to the annual withdrawal.”

That isn’t correct. For GLWB riders, allowing for a step-up each year if the account balance exceeds the benefit base, the underlying investments would need to exceed only 8.25%, assuming GLWB withdrawal occurs at the beginning of the year and expenses of 2.75% are assessed at the end of the year.

The step-up option is triggered when the account balance exceeds the benefit base, not when it exceeds the benefit base adjusted for inflation.

That said, Ms. Fox and Mr. Denning are quite right to say that contract earnings would need to be substantial in order to produce a withdrawal amount that would keep up with inflation. In this hypothetical case, investment earnings would need to be 11.5% in a given year for the step-up to create a benefit base sufficient to produce a 3% increase in the GLWB withdrawal amount.

Moreover, even if the contract were to earn more than 8.25% in a given year, it might not pay the contract owner to exercise the step-up, assuming that he or she has the option to do so, because many contracts provide that the GLWB rider cost may be increased upon such exercise. If a step-up exercise would increase the rider cost to, say, 1.4%, from 0.70%, earnings would need to exceed 9% for any step up to be profitable.

John L. Olsen
Principal
Olsen Financial Group
Kirkwood, Mo.

ADD YOUR VOICE to the mix. Readers: Keep letters brief. Include your name, title, company, address and a telephone number for verification purposes. Write, Attn: Jim Pavia, 711 Third Ave., Third Floor, New York, NY 10017-4033=6. All mail may be edited.