Cons of a guaranteed lifetime withdrawal benefit (GLWB)

What are the cons or downsides of a guaranteed lifetime withdrawal benefit (GLWB) from the annuitant's perspective?

Key Phrases: 

Good question.

First, a guaranteed lifetime withdrawal benefit is essentially the same thing as a guaranteed minimum withdrawal benefit that lasts for a lifetime.

The glossary definition of GLWB and a simple example of how it works can be found here:

It is important to remember that a GLWB is not a stand-alone product but rather an optional product feature (a "rider") that one can attach to a variable annuity.

In terms of GLWB cons, think of the following high level considerations:

1) Cost - there is a meaningful cost that you will have to pay to include this product option. This cost will vary from company to company. Shop around and ask your advisor or the insurance company what the cost is. The fees associated with a GLWB will be deducted from the account value--this decreases the account value and subsequently any annual payment increases that may be tied to that account value.

2) More on cost - the costs of these products are now higher in the wake of the financial crisis. Insurance companies use hedging programs to provide these living benefits. The cost of hedging has increased so living benefits are more expensive and have features that are less rich than several years ago. Take a look at the interviews with Ryan Hinchey to understand further:

3) Credit risk - the guarantee is only as good as the company providing it. Buy from a top rated variable annuity carrier such as MetLife.

4) Interest rates and benefit features - the GLWB is fixed and will be set at the time of contract issuance. Interest rates are low in the wake of the crisis. As a result and similar to all of the people buying fixed annuities over the past several months, you would possibly be locking-in the GLWB rate in a less than optimal interest rate environment.

5) Inflation - similar to the above, if inflation and interest rates increase significantly in the future then the real value of the GLWB will erode. It is difficult for the real value of GLWB payments to keep pace with inflation when fees/costs are considered. For example, consider a 5% GLWB and 2% cost. A 4% rate of inflation would mean that the real rate of return is actually negative.

6) Understanding how the benefit actually works - you need to find an advisor who can clearly explain to you what is available with a particular product/company and how it works.

7) Watch-out for "sunset provisions" which would terminate your ability to "step-up" the account value in response to market gains if/when you reach a certain age.

8) Find out how long step-ups in the benefit withdrawal base last (i.e. how many years or until what age).

9) What is the impact of taking the GLWB immediately or delaying to a later age? Generally, GLWB payments will be higher the longer you wait.

10) How does poor market performance and decreasing account value affect future step-ups in the benefit withdrawal base?

Excellent article! I believe you did allude to this in your article but one of the issues I see is that one of the things the GLWB rider entitles you to in many of the variable annuities is a "step up" in the account value depending upon market performance. The way I see it, if the contract charges are 3% (rounded) and you are entitled to a 7% annual withdrawal then in order for their to be a "step down" in the account value the underlying investments I selected would have to earn at least 10% since the contract charges and annual withdrawal amounts would be taken from and reduce the account value. I don't know that the market has consistently generated a 10% return especially for a 70/30 or 60/40 asset allocation that many of the variable annuities with the GLWB rider require you to have. Am I correct in my logic?

About 10 years ago I purchased the Scudder Destinations variable annuity with the GRIB rider which has proven to be a smart decision. Even though I paid in approximately $10K for the GRIB rider over the 10 year period it was definitely worth it in my opinion because at one time this year GRIB value was approximately $300K more than the contract value due to the poor market performance. That difference now is about $160K but in order to take advantage of the higher amount I would have to annuitize. Since I am not old enough to warrant starting annuitization I am kind of forced to leave my money in the contract because I would leave too much money on the table if I were to surrender the contract.

The above scenario is exactly why someone should consider a variable annuity. The income benefit you have is almost double what the account value is. For a portion of your assets, this type of income base planning makes a lot of sense. Not all annuity contracts require you to annuitize in order to receive the income benefit. In fact, most of the large insurance companies allow you to withdraw your guaranteed amount and still have control over the account value. This is assuming you are 59 1/2 years of age or older. At some time in the future, if your account value and income benefit values are closer, you might want to consider a 1035 exchange into a product that will allow for more flexibility. This is assuming a lot of the stock market in the next few years, but something to be aware of anyway. As for the insurance companies increasing the rates for the variable annuity products, this is not the case with all providers. Insurance companies are starting with making changes to the guarantees and are trying to keep the costs in place as much as possible. Also, it is important to keep in mind that the annual step-up is an either/or proposition. You get to step-up either market performance, less fees, or the guaranteed crediting rate. Obviously, if you have a few bad years on the front-end of your annuity contract, it will take a while to make that up in order to catch up and surpass whatever your yearly guaranteed crediting rate would be. As for the 10% calculation you referenced, this is exactly how your annuity would be treated once you begin taking income withdrawals. In order for your guaranteed income amount to grow and step-up during the income distrubution phase, you would have to do better than the guaranteed withdrawal rate plus all fees for the annuity. However, you would be entitled to take the guaranteed rate for the rest of your life, regardless of market perfomance. I realize the fees for these products and hefty, but what other options are available that provide as many guarantees as variable annuities potentially provide?

To chime in, here are some of the traditional complaints against variable annuity guarantees and my comments:

1) Additional cost for the guarantee that will reduce asset growth (as mentioned above). However, I believe this fits into the risk / return paradigm of investing. The higher potential for return, the more risk the investor must be willing to take. And conversely, if you want a guaranteed floor & longevity protection on your investment, then you'll have to sacrifice some of the upside potential.

2) Withdrawal penalty for taking out funds earlier than intended. The most popular base va product (prior to 2009) would typically penalize the investor if they take out more than the alloted withdrawals (i.e. 10% of the investment plus earnings) in a given year, during the first 7 years. This is similar to investing in a cd and then cashing in before it matures. The fact is that variable annuities are meant to be long term investments, and therefore, if policyholder needs to cash out early (i.e. due to an emergency), then they may be penalized. I would note that there are nursing home waivers, that allow the investor to take excess withdrawals without a penalty, if certain circumstances arise. In addition, more insurers today are moving away from the 7 year "surrender charge" period and promoting products with either a 3 year period or none at all. However, a lower surrender charge period will typically increase the annual fees, or include a front end load of around 3%.

3) Product Rules, Restrictions & Complexity. Each product is different, and has their own set of rules in how they work. Therefore, it is important to have a good financial adviser that understands these features and can clearly explain them to you. In addition, its easy for investors to get confused with their actual account value and their guaranteed base amount. These are two separate components. The account value is the amount available if the investor needs to surrender their contract. It also factors into the payout for a basic death benefit, and determines if a ratchet (= step up) occurs. On the other hand, the guaranteed amount is used to determine the amount that the policyholder can withdraw each year for the rest of their (& spouse's) life, if they play by the rules (i.e annual withdrawals of 5% of the guarantee base). Typically a GLWB's guaranteed base amount will never be reduced for fees or "non-excess withdrawals," while having the upside of increasing for ratchets, deferral bonus payments, and rollups (depending on the product features). However, the policyholder cannot access the entire guaranteed base amount at once in a surrender.

Also, the guaranteed minimum income benefit (GMIB) breed of products force the policyholder to annuitize before they access their guaranteed amount. This means that the policyholder would get a fixed payout for life, but loses access to their account value and their death benefit. Therefore, GMIB products are not ideal for individuals who would like to have a death benefit with their product.

In summary, just as a sports car may be the right purchase for one individual while a station wagon makes sense for someone else, retirement products come in different forms and it is essential to purchase the right product for your set of circumstances.

Many of the statements above regarding pros and cons of GLWBs are impressions and opinions. I have written a white paper that was published in the Journal of Financial Services Professionals on the subject. You might find it of interest as it takes an academic approach to the question. You can find the paper here:

This is great Garth--thanks very much for posting.

- Tom


I find this very insightful. I'm a newbie to Annuities. This information is great.