Most people, and seniors in particular, love investments with guarantees. But is the cost of the guarantee worth it?
We emphasize this point so you don’t get the wrong impression from previous columns we’ve written on guaranteed minimum withdrawal and income benefits offered by many variable annuities. From reader e-mails, it appears many of you believe we are endorsing these products without reservation, and we aren’t.
Under a guaranteed lifetime minimum withdrawal benefit, the insurance company that issues the annuity guarantees that, under a worst-case scenario, you will be allowed to withdraw a minimum amount from the annuity every year for life.
A typical withdrawal amount is 5 percent of your original investment. If the withdrawals and/or poor investment returns deplete the account, the insurance company will keep paying you out of its own money.
Under a different guaranteed minimum income benefit, the insurance company guarantees that the annuity will pay you at least a minimum income for life, usually starting 10 years after you buy it. With this benefit, you give up access to your principal.
Either benefit can be valuable, providing a safety net that encourages normally risk-averse investors to seek higher potential returns from investments in stock fund sub-accounts within the variable annuity.
But the cost of the guarantee, whitch is subtracted from your account value, eats into those returns.
Details on guarantees and costs can be enormously complex and vary widely throughout the industry.
Obviously, you need to know the minimum you’d receive under the guarantee, in dollars and cents a year. You need to know the cost, also in dollars rather than just percentages, and how that cost is likely to detract from returns.
For annuities with a guaranteed minimum income benefit, you also must understand that a number that insurance companies like to hype - the “guaranteed income base” or similar name - can be grossly misleading.
That “income base” is not cash but merely a figure used to calculate your annuity payments. And for these calculations, insurance companies use “annuitizaton factors” not nearly as good for you as their regular formulas.
To protect yourself, you need to ask how much it would cost, using normal “annuitization factors,” to receive the income guaranteed by the annuity benefit. (In one case, a $162,899 “income base” provided only as much income as you could have bought on your own with $89,288.)
“It means the guarantee is nowhere near as good as it is made to seem in the bold print,” said David Jacobs, a certified financial planner in Kailua, Hawaii. “Virtually no one understands how minimal the guarantee is, and how expensive.”
One reason is that cost figures also can mislead. The guarantee typically costs 0.50 percent or more of the “guaranteed income base” each year, but that can be a much higher percentage of the actual account value. Before you buy, know what the minimum cost will be, in dollars and cents, from year to year.
Costs are also a key factor with annuities offering guaranteed lifetime withdrawal benefits. Often, when you add the cost of the benefit to regular annuity charges and sub-account expenses, 3 percent or more of you account value is being siphoned off each year. That’s a high hurdle for your investments to overcome, particularly if you invest conservatively. (Georgina owns an annuity with this benefit, but total annual expenses are only about 2.25 percent and she can invest in diversified portfolios with up to 80 percent stocks.)
Humberto and Georgina Cruz are a husband-and-wife writing team who work together in this column. Send questions and comments to AskHumberto@aol.com or GVCruz@aol.com.