I don't think I made any indication that an annuity was truly as cut
and dry as my "S&P example". If I did it wasn't my intention. Of
course, there are numerous caveats. I'll try to give a better primer
of an actual annuity below:
Account Growth: When an investor puts money into a variable annuity
with a GMIB rider (simply VA, henceforth) two "accounts" are
immediately created. One is the actual account value (AV) and the
other is the benefit base (BB). The AV experiences the actual returns
of the underlying investments. All fees and expenses are deducted from
the AV. The BB grows by the guaranteed 6%. At each contract
anniversary the BB can be "locked-in" at either the AV or BB,
whichever is greater.
Ex: Annuitant invests $100k in the S&P500 fund of a VA. At year's end
the investment has returned 15%. The AV is now $112k (15% minus 3% in
fees). The BB is the greater of $106 or $112k. The next year, the S&P
returns 0%. The AV is now $108,640 (0% minus 3% fees). The BB,
however, is the greater of $108,640 or $118,720 ($112k x 6%).
The distinct accounts are very im****tant. The annuitant can call and
request the entire AV at any time (minus any applicable surrender
costs). The BB is not available for withdrawal. The BB is similar to a
defined benefit pension. It's amount off of which the insurer
guarantees an income stream. Liquidity is the true drawback of
annuities, not returns.
Distributions: Funds can be withdrawn from variable annuities without
"annuitizing" the contract. This is actually the far more common
scenario. If the above annuitant wanted to withdraw 6% of the BB at
year's end, the AV would fall to $101,920 and the BB would stay at
$112k.
Annuitizing: If the AV ever reaches $0.00, the contract is annuitized
using the annuitant's life expectancy and the BB. Going back to our
above example, let's assume the market has a run of bad years and in 5
years the AV has fallen to $0 (REALLY bad years, but it's just an
example). The BB has risen to $166,329 ($118,720 grown at 6% annually
for 5 years). At that point, the client has the equivalent of a
$166,329 immediate annuity. There is no account value to liquidate or
withdraw from, only a promised income stream (again, like a pension).
That's the basics. I do believe the 6% guarantee stops compounding
annually at age 90 (I think it was 85 and they are currently moving it
to 90). Annuities do not receive a stepped up basis at death and the
gains are taxed at ordinary rates. Those are definitely negatives. On
the other hand, growth is tax-deffered and there's no guarantee as to
future tax laws.
One often ignored benefit of the VA is that the guarantee allows
investors to take on more risk. A retired investor will commonly have
60-100% of their investments in fixed income. That same retiree
investor has less need to carry safe investments if the guaranteed
annuity promises a 6% compounding pension. The fixed income/bond/muni/
CD retiree may only get a 5-6% return. On the other hand the VA
investor may get 8-9% in equities. After expenses the returns are the
same and the VA guarantees have paid for themselves.
Probably my longest post ever. I apologize. I welcome the responses.
P.S. - I would make about $6k in commission in the above example.
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