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 immediateannuities.com, $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:

• Income Annuities versus GLWBs: A Product Comparison (pdf) from Joe Tomlinson
• Annuities versus Systematic Withdrawals: Understanding Tax Effects (pdf) from Joe Tomlinson
• GLWBs: Retiree Protection or Money Illusion? from Wade Pfau
• On the Pros and Cons of GLWBs (a followup to the prior article)

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.