Variable Annuities With Living Benefits: Worth the Fees?

There is an ongoing debate in the financial services industry about the usefulness of variable annuities and the purpose they serve in an individual’s financial portfolio. Many feel that variable annuities are not suitable for the majority of investors, especially as the financial benefits are often eroded by fees and penalties.

However, some added features may make a variable annuity suitable for certain investors, depending on the investor’s financial profile and retirement horizon. Below, we'll take a look at the living-benefit feature and how it might or might not benefit you. In addition, the new SECURE Act passed by Congress recently allows retirement savers to include annuities directly in their 401(k) plan, making it easier than ever to add these contracts to your retirement portfolio.

Key Takeaways

  • Investing in a variable annuity is less flexible than maintaining a traditional portfolio that invests in stocks, bonds, and mutual funds.
  • A variable annuity with a living-benefit feature is particularly suited for people with a low-risk tolerance and limited funds.
  • A living-benefit feature in a variable annuity will inevitably come at a price: additional fees.

Variable Annuities: A High-Level Primer

A variable annuity is a tax-deferred financial product that pays benefits to you over a specified number of years and a death benefit to your beneficiaries. The benefit you receive is usually based on the purchase payments and the performance of the underlying investments. The underlying investments can be diversified and rebalanced, which provides you with the flexibility to monitor and manage your portfolio.

However, a variable annuity product may be subject to a variety of fees:

The Living-Benefit Feature

The living-benefit feature is usually optional and available at the cost of paying additional fees. However, despite the additional cost, some financial advisors and consumers feel that it is worthwhile to receive the guaranteed benefits provided. The living benefit—as the name suggests—is intended to guarantee the benefit provided, and toward that end, it usually offers guaranteed protection of the principal investment and the annuity payments or guarantees a minimum income over a specified period to you and your beneficiary.

There are several types of living-benefit features, including the following:

Guaranteed Minimum Accumulation Benefit

The guaranteed minimum accumulation benefit (GMAB) ensures that the value of the annuity will not fall below the principal investment amount, which is referred to as accumulation, regardless of the market performance of the underlying investments.

Of course, withdrawals are not factored into this guarantee, as they will reduce the amount of principal. In order to be eligible for it, the contract usually includes a stipulation that requires the principal investment to be held for a minimum period, with no withdrawals occurring during that period.

Guaranteed Minimum Withdrawal Benefit

The guaranteed minimum withdrawal benefit (GMWB) usually states that you will receive a designated amount through withdrawals from the annuity. At a minimum, the aggregate total withdrawals will be no less than the principal amount invested, but it can be more than that amount.

Generally, the guarantee covers a minimum principal payment over a fixed period or over the life of both you and your beneficiary, with payments continuing to your beneficiary after your death.

Guaranteed Minimum Income Benefit (GMIB)

Under the guaranteed minimum income benefit (GMIB) feature, you are promised a minimum rate of return on the principal regardless of the market performance of the underlying investments. Based on the return, you are guaranteed minimum annuity payment amounts, which can be more than projected if the market performance of the investments produces a rate of return that is higher than the guaranteed minimum rate of return.

Usually, the principal amount is required to remain untouched for a minimum number of years in order for you to be eligible for this benefit.

Not a One-Size-Fits-All Solution

The actual name used to label these benefits may differ among financial institutions, and the specific provisions of the products may also vary. As such, you should review the features of the products in which you are interested to determine if they include the benefits you desire.

While the guaranteed benefits are often the most attractive features of these fixed annuities, it still does not provide a one-size-fits-all solution, and suitability will depend on your needs and financial profile.

Living Benefits vs. Traditional Portfolios

Investing in a traditional portfolio that allows direct investments in stocks, bonds, and mutual funds provides more flexibility than investing in an annuity. However, investment risks can be tempered or even eliminated with a variable annuity that includes a GMIB feature.

In addition, the living-benefit feature can help to provide peace of mind through guaranteed income for people with no risk tolerance due to factors such as limited assets in their retirement nest egg, a short retirement horizon, or just simply extreme caution about losing market value on investments.

On the other hand, investing in a variable annuity allows limited control over when you receive income and the amount of it. Once the income amount and annuity period and schedule are determined, you are usually locked into them, except for when the amount decreases or increases due to market performance. A traditional investment portfolio allows more flexibility, as you can withdraw any amount or percentage based on the financial need or want at the time of withdrawal.

Determine Suitability Before Buying

In 2019, the stock market hummed, but there were times—and they will come again—when many investors began to see their retirement portfolios losing significant market value. In such times, a variable annuity with a living-benefit feature can be a good solution for protecting your nest egg.

In other situations, though, it may not be. For instance, consideration must be given to your life expectancy. Will you likely be able to take advantage of the living benefits? If you have a debilitating illness or short life expectancy, a variable annuity—including one with a living benefit—may not be a good addition to your retirement portfolio.

If your financial advisor is receiving a commission for selling you a variable annuity, make sure that you know what you are getting in exchange for that commission.

Research and Comparison Shop

One of the negative opinions about annuities is that they are often pushed onto unsuitable investors because of the high commission that the investment advisor usually receives for selling the product. This is not always the case, however, as many financial advisors do work with clients to ensure that they receive products that are suitable for their financial and retirement profiles.

Furthermore, you can choose to buy these products directly from issuers that do not receive a commission from the sale. In many cases, additional services and customer support are provided in exchange for the commission.

That said, if paying the commission elicits no added benefits, then it may make sense to purchase the product from a self-service provider. As such, you should ask yourself or your investment advisor what is received in return for the commission.

The Bottom Line

A key determining factor that affects your choice between an annuity and a traditional portfolio is your need for guaranteed income. If you have little or no risk tolerance or limited financial resources, an annuity may provide the needed guaranteed income stream. Determination of suitability cannot be overemphasized and is not usually based only on the size of your nest egg and the length of your retirement horizon.

Pairing unsuitable products with investors is one of the worst mistakes that can be made with financial planning. For many people, buying an annuity is the last step taken on their way to retirement, and often the mistakes cannot be corrected without costing them large amounts of fees. So special care must be taken to ensure that you not only understand an annuity's benefits and features but are also aware of how they compare to other financial products.

Article Sources
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  1. Society for Human Resource Management. "SECURE Act Alters 401(k) Compliance Landscape."

  2. U.S. Securities and Exchange Commission. "Guaranteed Minimum Accumulation Benefit Rider (GMAB)."

  3. U.S. Securities and Exchange Commission. "Guaranteed Minimum Withdrawal Benefit Rider."

  4. U.S. Securities and Exchange Commission. "Guaranteed Minimum Income Benefit Rider."

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