Most people dream about living a long and fulfilling retirement, free of financial worries. But we know that there are very real threats to our retirement nest eggs. The challenge lies in protecting our retirement goals and dreams from risk. This guide is here to help you learn more about one of the most viable nest egg protection tools available — variable annuity lifetime income benefits that provide a guaranteed income stream for life.
Why Your Retirement Nest Egg Needs Insuring
Any investor who has witnessed the damage done to their portfolios by recent periods of financial market upheaval needs no reminder of how difficult it can be to navigate the road to, and through, retirement. It’s a road fraught with uncertainty and unanticipated obstacles.
The good news is that the average 65-year-old retiree today can expect to live another 20 years, and there’s a 25% chance that for a couple, one spouse will live past age 95. But with longer life expectancies come huge big-picture questions about our financial futures: Is my retirement nest egg big enough to provide a comfortable level of income for my entire life? Will I outlive my assets?
How a person answers those questions depends largely on the steps they take to protect their nest egg from longevity risk (the risk of outliving your retirement savings) and financial market risk (the risk a market downturn will do irreparable damage to a retirement portfolio). These are two of the biggest threats to a retirement portfolio.
In light of those risks, financial experts now recommend that investors consider allocating a portion of their retirement savings to insurance-based products such as variable annuities that carry optional features known as lifetime income benefits — LIBs for short. For a fee, such a feature (also known as a guaranteed lifetime withdrawal benefit, or GLWB) provides the owner of the annuity contract with a guaranteed stream of income, for life.
Read on to find out exactly how lifetime income benefits work, what they cost, whether they’re suitable for you, and if so, how to find one that best fits you and your financial situation.
What is a Lifetime Income Benefit?
Uncertain times call for financial planning tools that offer certainty. Having a variable annuity with an lifetime income benefit means the insurance company underwriting the annuity contract is obligated to provide you with a certain level of income for life — regardless of how the annuity performs, regardless of how your other investments perform, and regardless of how the stock market itself performs.
Some other things you should know about lifetime income benefits:
- Lifetime income benefits start providing regular income (monthly, quarterly, etc.) once the annuity owner hits a specified age, such as 65 or other retirement age of their choosing.
- Lifetime income benefits are designed to keep providing income, even if all the assets held in annuity accounts are exhausted.
- A lifetime income benefit is an optional “rider” that carries an annual fee, typically calculated as a percentage of the benefit base or contract value.
- The lifetime income benefit typically must be elected at the time the annuity is purchased (although the income start date can be elected at the desired retirement date in the future).
- Both the annuity contract and the lifetime income benefit rider guarantees are backed by the insurance company issuing the annuity.
- The annuity contract value is paid to the investors’ beneficiaries on death, so it functions as a vehicle for transferring wealth to heirs. Optional enhanced death benefit riders can be selected to pay out a larger amount upon death.
- Many lifetime income benefits allow investors to base the withdrawal percentage on some minimum compounded growth rate (such as 5%). If your account value appreciates, you typically have the option of locking in the increased account value on a contract anniversary — also referred to as “stepping up” or “resetting” the amount on which the withdrawal percentage is based.
Do I Need a Lifetime Income Benefit?
Try answering the questions below. If you answer “yes” to at least one of them, you may be a strong candidate for a variable annuity with a lifetime income benefit.
- Are you planning on having a lengthy retirement of say, 20 or 30 years or more?
- Are you concerned about outliving your retirement savings?
- Do you want to protect your retirement portfolio from market downturns such as the one in 2008?
- Do you expect to need more income during retirement than the amount you expect to receive from Social Security and/or a pension?
- Do you want to leave a financial legacy for family members, or to your favorite charity?
- Do you want to spend your retirement enjoying life, rather than worrying about the performance of the stock market?
- 80% of American workers are expected for fall short of meeting all their financial needs in retirement.
- A growing number of Americans are being forced to delay retirement because they didn’t adequately save or plan for their retirement income needs.
- 51% of American households are at risk of being unable to maintain their pre-retirement standard of living in retirement, even if they work to age 65.
- Recent Social Security Administration calculations indicate that the Social Security system could be insolvent by 2036, potentially eliminating a key source of retirement income.
*In order of appearance:
- “Hewitt Study Shows Four in Five Americans Not Expected to Meet All of Their Financial Needs in Retirement,” Aon Hewitt press release, May 3, 2010.
- “Retirement Confidence Survey 2011,” Employee Benefit Research Institute, March 15, 2011.
- “The NNRI and Annuities Fact Sheet,” The Center for Retirement Research at Boston College, October, 2010.
- “The 2011 Annual Report Of The Board Of Trustees Of The Federal Old-Age And Survivors Insurance And Federal Disability Insurance Trust Funds Communication,” OASDI, May 13, 2011.
How Lifetime Income Benefits Work
Let’s say you decide to invest $300,000 in a variable annuity with an optional 5% lifetime income benefit rider. Once you sign the contract, the insurance company guarantees you $15,000 annually for the rest of your life even if the balance of your account falls to zero along the way.
The following three scenarios (referencing the same $300,000 annuity and 5% rider) demonstrate how powerful this annuity/rider combination can be in various markets.
Scenario 1: The market performs poorly in the years before your retirement…
Ten years after your initial investment, you decide to retire, but due to poor market conditions, the value of your annuity has dropped to $150,000. However, because of the minimum compounded growth rate of 5%, your withdrawal will be calculated from roughly $489,000 – 5% growth on $300,000 for the past 10 years. This would give you nearly $25,000 every year for the rest of your life, even if the market never recovers.
Scenario 2: The market performs well in the years before your retirement…
Five years after your initial investment, you decide to retire. Luckily, the market had a great few years and now your annuity is worth $600,000. That growth is much higher than the 5% annual minimum. You can now take 5% withdrawals on the benefit base of $600,000. This equates to $30,000 annually for the rest of your life, even if the account value falls to $0.
Scenario 3: The market performs unevenly in the years before your retirement…
Eight years after your initial investment, the account value has risen to $425,000, but the following year, the market crashes and does not recover by the time you’re ready to retire in year 12. Luckily, you selected a LIB rider that offers annual step-ups, and you stepped-up your account value to $425,000 during year eight. Even though when you’re ready to retire the account value has fallen to $235,000, your annual income is based on the step-up to $425,000. This equates to $21,000 annually for the rest of your life. Had you not elected a rider with a step-up feature, your annual income would be based on $235,000 – $12,000 annually for the rest of your life.
Shopping for Lifetime Income Benefits
All lifetime income benefits are not created equal, so shop around – with the help of a qualified financial professional you trust. The process involves three steps:
Step 1: Evaluate the Features of the Riders Themselves
- Look for a lifetime income benefit of at least 5%. Bottom line: you want to be sure the lifetime income benefit’s maximum withdrawal amount is consistent with your income needs.
- Look for a plan with a strong step-up feature, which allows you to “reset” and lock into the contract’s highest anniversary value whenever the actual account value exceeds the guarantee, and then receive income off the new, higher number.
- If you have a spouse, look for a spousal lifetime benefit of 5% to 6.5%, so if one spouse dies, the surviving spouse gets the withdrawal benefit for as long as he or she lives.
- Compare rider fees. Keep in mind, a lower fee does not always mean a better lifetime income benefit. Other factors, such as step-up, maximum withdrawal percentage, and other plan features, should also be part of the equation.
- Look for a plan that allows resets to advanced ages. We generally favor plans that allow resets until age 85+.
Shopping for Lifetime Income Benefits
Step 3: Evaluate the Insurance Company
- The income-for-life guarantee on which lifetime income benefits are built is only as strong as the insurance company offering it. So for peace of mind, don’t settle for less than a highly rated insurance company. That credit rating speaks to its claims-paying ability and its overall financial strength. A quick visit to AnnuityFYI will get you updated side-by-side insurance company ratings from the four major ratings agencies.
- Look for an insurance company with strong management and customer service, along with simple, transparent account access, management and reporting.
Three Keys to Maximizing Lifetime Income Benefits
- The younger the age at which the lifetime income benefit is purchased, the more valuable the withdrawal guarantee (except in designs where the roll-up ceases at a particular future date).
- The sooner withdrawals begin, the less valuable the withdrawal guarantee.
- A higher payout rate will result in higher cash equivalent annual return on the investment (since the monthly income guarantee would be higher).
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