Variable annuities offer retirement savers a chance for higher returns than they are likely to get from fixed annuities. But, because variable annuity returns are based on underlying investments in the markets, returns may also be lower. To avoid the risk of running out of money in retirement due to a market downturn, a variable annuity buyer can opt for an optional rider called a guaranteed minimum income benefit (GMIB). For a price, this guarantees the annuity buyer will get at least a minimum monthly payment, no matter what happens in the markets.
If you want help with buying annuities or any financial planning concerns, consider working with a financial advisor.
Annuity Basics
An annuity is a contract with an insurance company that offers a regular stream of future payments in returns for an upfront payment of principle. This payment may be a single lump-sum premium or be paid in installments.
Annuities are structured with accumulation phases, during which earnings from investing the principle grow, and distribution phases, during which the buyer begins receiving payments. One benefit of annuities is that the annuity buyer doesn’t pay federal income taxes on earnings from investing the principle until withdrawals begin.
There are many varieties of annuities but most can be divided into either fixed or variable types. Fixed annuities have a set interest rate that never varies despite market trends, and also offer buyers predictable unvarying payments.
With variable annuities the rate earned by the principle can change according to the value of underlying investments, which may be stocks, bonds, mutual funds or other securities. Due to market volatility, a variable annuity may earn less some years. If an annuity buyer keeps withdrawals constant when investment earnings decline, it’s possible to run out of principle and for the payments to stop.
The GMIB addresses that possibility by guaranteeing to maintain at least a minimum level of payments. To receive this benefit, buyers pay an added fee to the insurance company.
How GMIBs Work
GMIBs may also sometimes be called guaranteed interest accounts, guaranteed retirement income programs and other names by the insurance companies that sell them. Most work the same way. An annuity with a GMIB rider maintains two accounts. One, the investment account, contains funds the buyer can direct into a limited set of investments, usually low-cost mutual funds and index funds. The other account, the GMIB, is professionally invested.
The amount of the monthly, quarterly or semiannual payout to the annuity buyer is determined by the market value of the investment account or the market value of the GMIB account, depending on which one is larger.
If, for example, an annuity buyer purchased a GMIB rider that guaranteed 6% earnings but the market only returned 5%, the GMIB account would be larger and the payment would be based on that account. The actual amount of the payments depends on the size of the principle and the length of the annuity, among other factors.
Annuity buyers can, with some restrictions such as having to pay penalties or wait until several years after funding the annuity, generally withdraw the entire amount of the investment account. They can’t do that with the GMIB account. The GMIB account is used to determine and fund the payouts but the annuity buyer can’t withdraw that money.
GMIB Pros and Cons
The benefit of a GMIB is that it eases retirement savers’ fears of running out of money in retirement. However, this advantage comes at an increase in cost and complexity.
The fees for GMIB riders can eat into investment returns, though. For instance, one popular GMIB rider charges 1.25% in fees each year. This is on top of the already hefty fees annuity sellers charge for operations, administration, distribution and other costs.
GMIB riders are also complex. It may be difficult for a buyer to understand the guarantee, the cost and exactly how future payments will be calculated.
Another limitation of GMIBs is that, while they are common, not all companies offer them. Finally, most GMIBs have age limits.
Bottom Line
GMIBs can address retirement savers’ worries about running out of money in retirement by promising that, no matter what happens in the market, they will receive at least a minimum regular payout. They are commonly offered as riders on variable annuities. GMIBs add cost and complexity to annuities, but they can be useful tools in retirement planning.
Tips on Retirement
- An experience and qualified financial advisor can help you decide whether and how to use annuities. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area in 5 minutes. If you’re ready to be matched with advisors that will help you achieve your financial goals, get started now.
- Don’t rely solely on an annuity. Make sure you’re saving with a workplace saings account like a 401(k) if you have access to one, or an individual retirement account (IRA) if you don’t.
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