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Are Guaranteed Living Withdrawal Benefit (GLWB) Riders a Good Idea?

A reader writes in, asking:

“What do you think of the ‘Secure Income’ rider product for the Vanguard Variable Annuity? I find the combination of safety and flexibility to be very appealing, yet I have learned from bogleheads that a 1.2% fee is not something to be taken lightly.”

As we discussed earlier this year, in general I think that deferred variable annuities are most useful either as:

  1. A tax planning tool in uncommon circumstances, or
  2. A tool to get out of an even less desirable insurance product via a 1035 exchange.

What is a Guaranteed Living Withdrawal Benefit (GLWB)?

For those who are unfamiliar with the product, the “Secure Income” rider for the Vanguard variable annuity is a “guaranteed living withdrawal benefit” (GLWB) rider. With a GLWB rider, you agree to pay an extra annual expense, and in exchange you are guaranteed to be able to withdraw a certain amount per year from the account for the rest of your life.

In other words, a GLWB is kinda-sorta like having the benefit of a regular lifetime annuity, without having to annuitize the account (i.e., without having to turn over the assets). But you pay a significant annual cost for that benefit.

In the case of Vanguard’s GLWB, the annual cost is 1.2% of the “Total Withdrawal Base.” And the amount you are guaranteed to be able to withdraw per year is also a percentage of the Total Withdrawal Base (e.g., 4% for an individual who starts taking withdrawals between ages 59 and 64).

The Total Withdrawal Base starts out as the account value when you activate the GLWB rider. And each year it is recalculated as the greater of either 1) the existing Total Withdrawal Base or 2) the current account value. In other words, the Total Withdrawal Base will not go down as a result of poor investment performance — which means that your annual guaranteed withdrawal will also not decrease as a result of poor investment performance.

Are GLWB Riders a Good Idea?

Relative to simply owning the same variable annuity (without purchasing a rider) and taking the same size distribution each year as would be provided by the rider, the rider’s overall effect is to:

  1. Accelerate the likelihood and rate of account depletion (because of the additional cost), but
  2. Guarantee that income will still continue to be paid in the event that the account is depleted (because the TWB is locked in at a higher value).

Increasing the annual withdrawal rate from a portfolio by 1.2% (as would be the case when the Vanguard GLWB is activated) significantly increases the rate at which the portfolio will be depleted. In addition, if/when the account value does fall at some point, because the TWB is “locked in” (i.e., it doesn’t fall), the GLWB fee (1.2% of the TWB) will actually be more than 1.2% of the account value, which will cause the account to deplete even faster.

In short, the GLWB rider has the effect of guaranteeing some level of income, at the cost of reducing the amount that is ultimately left to heirs. Of course, that in itself isn’t necessary a bad tradeoff. Plain-old lifetime SPIAs involve the same tradeoff, and they’re broadly considered to be a useful tool in financial planning.

So the question is primarily: is the GLWB a good deal? That is, is the safety added by the guarantee worth the cost? Or would there be a more cost-effective way to get the same level of safety?

For instance, for a 62 year old male, the Vanguard GLWB rider guarantees a 4% income stream. So a $100,000 account would produce $4,000 of annual income (to start with — it could go up if the portfolio performs well soon after activating the rider).

Conversely, based on a quote from, $64,620 would be enough for a 62 year old male to purchase a lifetime SPIA that guarantees $4,000 of annual income. And that would leave $35,380 to be invested as desired to leave to heirs, provide for spending increases later, or some combination thereof.

Which is likely to work out better? That depends on investment performance as well as how long the person lives. In short, it’s not an easy question to answer.

And this, to me, is one of the reasons why I think most people (not necessarily everybody) should stay away from riders (and to a lesser extent, variable annuities in general) — it’s quite hard to analyze whether a specific guarantee is worth the cost. Earlier this year I wrote the following about variable annuity riders in general, and I think it’s applicable here:

The insurance company has a team of actuaries, financial analysts, and attorneys working together to create the product in such a way that they believe it will be profitable for them. The consumer, on the other hand, doesn’t have nearly the same level of information or analytical ability.

And when a financial services company has a significant information advantage over the client (that is, when the client can’t really tell whether they’re getting a very good deal, a very bad deal, or somewhere in the middle), it is not usually the financial services company that gets the short end of the stick.

As far as analyses that have already been done by smart, qualified people, here are a few that may be of interest:

One thing we can say with a high degree of confidence is that if our hypothetical 62 year old male has a desire for safe lifetime income, one thing he should definitely be doing before purchasing either type of annuity is delaying Social Security. With interest rates as low as they are right now, the deal offered by delaying Social Security is meaningfully better than the deal any insurance company would offer on an annuity.

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Investing Blog Roundup: In Defense of the Easy Way

As we’ve discussed at various points previously (here, for example), it’s the overall allocation of your portfolio that matters, not the allocation of each individual account. And, given that fact, you can often minimize costs (either in the form of expense ratios, tax costs, or both) by allocating each account differently to take advantage of the best option(s) for that particular account.

As Jim Dahle recently pointed out, however, some people will find the “all one portfolio” approach to be rather harder to implement than the “same allocation in each account” approach. And that’s not a trivial point. It’s important to be able to confidently manage your portfolio.

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What’s the Maximum Expense Ratio Somebody Should Pay for a Mutual Fund?

A reader writes in, asking:

“As I try to select among the funds in my 401k plan, is there a limit to the high end of expense ratio that you suggest not going beyond?”

The maximum expense ratio that I would pay for a fund depends on the context. Specifically, it depends on the availability of a less expensive suitable substitute.

For example, consider an investor with a $100,000 portfolio, all of which is in her 401(k). She has decided that her ideal asset allocation would be:

  • 60% in US stocks,
  • 20% in international stocks, and
  • 20% in bonds.

And, in her 401(k), the lowest-cost investment options in each of those categories are:

  • A “total stock market” index fund with an expense ratio of 0.1%,
  • An actively managed international stock fund with an expense ratio of 0.7%, and
  • A “total bond market” index fund with an expense ratio of 0.1%.

Our investor has a dilemma. She wants a 20% international stock allocation in her portfolio. But she would have to pay an extra 0.6% per year for that part of the portfolio in order to have such an allocation (rather than just allocating the entire stock part of the portfolio to the US stock index fund).

Frankly, if I were in that position, I wouldn’t pay the additional cost. I appreciate international diversification, but an avoidable cost of 0.6% per year is a high hurdle for the diversification to overcome in terms of added value.

But what if our investor’s lowest-cost investment options were as follows?

  • An actively managed US stock fund, with an expense ratio of 0.65%,
  • An actively managed international stock fund with an expense ratio of 0.7%, and
  • A “total bond market” index fund with an expense ratio of 0.1%.

In this case, our hypothetical investor would now only be paying an additional 0.05% per year for her international allocation. The international fund’s cost hasn’t changed at all, but it has become quite a bit more attractive because the alternative (i.e., keeping the entire stock allocation in the US stock fund) has become more expensive.

Point being: The maximum expense ratio that it makes sense to pay depends on the cost and suitability of the nearest substitute. In our first scenario the 0.7% expense ratio was too high because there was a low-cost substitute (albeit an imperfect substitute). In the second scenario, the 0.7% expense ratio was not prohibitive, because there was no low-cost substitute.

What if There Are Multiple Accounts?

Let’s look at one more hypothetical scenario. Our investor still desires an allocation of 60% US stocks, 20% international stocks, and 20% bonds. And the options in her 401(k) are the same as in our first scenario above:

  • A “total stock market” index fund with an expense ratio of 0.1%,
  • An actively managed international stock fund with an expense ratio of 0.7%, and
  • A “total bond market” index fund with an expense ratio of 0.1%.

In this case, however, her portfolio consists of $50,000 in her 401(k) and $50,000 in a Vanguard IRA. In this case, she has no reason whatsoever to pay the high cost of the international fund in her 401(k), because she could achieve her desired overall allocation by buying an international index fund/ETF in her IRA.

Again, the overall conclusion is that the maximum “acceptable” expense ratio for a fund varies based on the availability of less expensive suitable substitutes.

Investing Blog Roundup: What Drives Muni Bond Yields?

Relative to Treasury bonds, muni bonds often yield more than we would expect based on just the different tax treatment and different credit risk of the two types of bonds. So what’s the other characteristic of muni bonds that drives their yields up? Larry Swedroe takes a look at that question in an article this week at Advisor Perspectives.

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Why Don’t Vanguard’s Target Retirement and LifeStrategy Funds Own Admiral Shares?

One question I receive periodically is why the Target Retirement and LifeStrategy funds at Vanguard hold “Investor” shares of the underlying funds, rather than the less expensive “Admiral” shares. Emily Farrell, Head of U.S. Business PR at Vanguard, was kind enough to provide the answer.


Piper: Why don’t the LifeStrategy and Target Retirement funds use Admiral shares as the underlying holdings?

Or, if there’s a concern about that being a way to “cheat” to get access to Admiral shares without meeting the requirements, why not have an Admiral share class for the LifeStrategy and Target Retirement Funds, with a higher minimum investment (i.e., a high enough figure such that a person investing that amount via an identical DIY allocation would qualify for Admiral shares of all or most of the underlying funds)?

Farrell: Vanguard is unable to offer multiple share classes on funds of funds due to the structure in which we operate, and the agreement we have with the SEC regarding multiple share classes. Our funds of funds have no direct costs — the costs are derived only from the ERs of the underlying funds. According to that agreement, we must be able to offer a differentiated cost advantage between share classes. (Therefore, because there is no direct cost associated with a fund of fund — it’s not possible for us to offer such an advantage).

As you may recall, we launched a suite of Institutional TRFs in 2015. Note, however, those are not share classes — they are an entirely new set of mutual funds.

Piper: Given that Vanguard can only have one share class of a fund-of-funds, how does Vanguard decide which share classes to hold within such funds? The “normal” (non-institutional) versions of the funds-of-funds each hold Investor shares of the underlying funds. Would Vanguard ever consider holding Admiral share classes in these funds?

And, for example, the Vanguard Institutional Target Retirement 2050 Fund (VTRLX) holds Institutional shares of one underlying fund, Admiral shares of another fund, and Investor shares of two funds. What’s the line of thinking there?

Farrell: It is largely based on the cost to serve the underlying shareholder of the TRF or LifeStrategy Fund. These funds tend to attract small balance accounts and IRAs, and the cost to serve is disproportionately higher than funds with large and diverse shareholders. In terms of looking into adding holding Admiral in the Investor suite of TRFs, in short, the answer is yes — we consistently review our products, product structures, and product line-ups. However, given the size of the average TRF account and our cost allocation methodologies, we would not expect a change from Investor Shares. Specific to the underlying holdings of the Institutional suite of TRFs, again, it is cost to service the funds and our cost allocation methodologies that dictate the share class utilized.


So, to paraphrase, Vanguard’s position here is, “in a Target Retirement or LifeStrategy fund, we hold whichever share class (or share classes) result in an expense ratio that most closely reflects the cost to service the fund’s shareholders.” In hindsight, that feels sort of obvious, given Vanguard’s general “at cost” pricing philosophy.

Investing Blog Roundup: Retirement Income, Before Age 59.5

For people considering early retirement, an important part of the process is to plan for how you will satisfy your expenses prior to reaching the magical “age 59.5” threshold. In a recent article, Darrow Kirkpatrick (himself an early retiree) runs through the various options available, discussing the pros and cons of each.

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