Seniors looking for retirement income often purchase an annuity. Annuities provide guaranteed income for a determined period of time in exchange for premium payments earlier in life. Some investors do not want to annuitize their account, but still want to withdraw from their annuity to cover their expenses. A guaranteed minimum withdrawal benefit (GMWB) rider offers the best of both worlds.
With GMWB riders, owners receive a guaranteed withdrawal every year without having to give up control of their account balance. In this article, we’ll explain what they are, how they work, what they cost and how you can still participate in the upside of the market. For help understanding all sorts of financial questions, consider working with a financial advisor.
Guaranteed Minimum Withdrawal Benefit (GMWB) Definition
A guaranteed minimum withdrawal benefit rider is an add-on that you can purchase with your annuity. In most instances, these riders are paired with variable and fixed-index annuities. For an increase in annual expenses, you can withdraw a percent of your initial contribution amount every year. This is true, even if your account balance declines due to the performance of the underlying investments.
How GMWBs Work
When you purchase a guaranteed minimum withdrawal benefit rider for your annuity, payments typically do not start right away. Instead, your benefits start whenever you activate them. And, just like Social Security, you’ll receive a higher payout if you wait until you are older to activate your benefits.
You’ll allocate your investment among a variety of sub-accounts (similar to mutual funds) based on your risk tolerance and preferences. The account balance grows over time, just like your 401(k), IRA or brokerage accounts.
Once you activate the GMWB rider, you can withdraw up to a set percentage of your “benefit base” every year. This withdrawal percentage does not change and is determined by your age when the benefit is activated.
Your initial benefit base is the amount that you contributed to open your account. If your account balance drops due to market performance, your benefit base for withdrawals stays the same.
Multiplying your benefit base by your withdrawal percentage and determines your annual withdrawal amount.
However, if you withdraw more than the GMWB annual benefit, it could reduce the value of your account balance and affect future withdrawal amounts.
While your benefit base will not decrease, you can benefit when your account increases in value. As your account grows over time due to investment performance, you can lock in new a “high-water mark.” This increases the benefit base and your annual withdrawal amounts.
Locking in new high-water marks is generally done once a year. And once a new benefit base is determined, subsequent decreases in investments will not erode your new baseline for benefits.
Example of an Annuity with a GMWB
Let’s say that you spend $100,000 to buy an annuity with a GMWB rider. Based on your age of when you activate your benefit, you receive a 5% annual benefit. This means that you’ll receive $5,000 per year from your account.
After a year, your account has grown to $120,000. This new high-water mark is then multiplied by your 5% GMWB to equal a $6,000 annual withdrawal.
New high-water marks may happen repeatedly as your underlying investments increase in value. There is no additional charge for increasing your income other than the annual expense of the GMWB rider.
How Much Does a GMWB Rider Cost?
Guaranteed minimum withdrawal benefit riders typically cost between 0.5% and 1% of your annuity balance. This cost is combined with the fees and expenses that you’re already paying (e.g: the mortality and expense (M&E) charges and underlying investment fees).
Alternatives to a GMWB
If you are unsure about purchasing a guaranteed minimum withdrawal benefit rider for your annuity, here are alternatives to consider:
- Period certain annuity. In exchange for your contribution, you (or your estate) will receive guaranteed monthly payments for a period of time. If you live longer, you’ll receive payments for the rest of your life. If you pass away before the period expires, your estate will receive a lump sum or monthly payments for the remaining balance.
- Brokerage account withdrawals. A brokerage account provides access to market performance with lower expenses than an annuity. However, it doesn’t provide guarantees against market declines or annual withdrawals. If your brokerage account declines in value, you may have to lower or eliminate withdrawals until the balance recovers.
Why Would You Add a GMWB Rider to Your Annuity?
A GMWB is an attractive option for retirees who do not want to annuitize their accounts. Annuitization requires giving up your account balance in exchange for a guaranteed monthly payment for the rest of your life. This can be a wonderful deal if you live for a long, but financially disastrous if you die quickly after taking this option.
With a GMWB, you are able to withdraw a set percentage of your account’s value without affecting your ability to withdraw more, move your balance to another investment or leave the account to your estate.
The Bottom Line
Purchasing an annuity doesn’t mean giving up control of your investments. With a guaranteed minimum withdrawal benefit rider, you can receive regular income without annuitization. Step-up provisions provide the potential for the increased value of your account and higher income. While these guarantees do increase your annuity’s expenses, they can be a valuable addition to your retirement income strategy.
Tips for Creating Income in Retirement
- Determining how much income you can receive in retirement is one of the most important steps in creating your retirement plan. Our retirement calculator helps you figure out income, taxes and expenses to determine if you have enough money saved.
- A financial advisor can help with annuities and other financial questions. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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