A guaranteed withdrawal benefit rider is an option that you can add to either a fixed or variable annuity. It allows you to to withdraw funds from your annuity, while continuing to draw lifetime income benefits.
When it comes to annuities, there are generally two ways that you can take withdrawals from the plan:
- “Annuitize” the funds – which means creating regular distributions, or
- Make the withdrawal, and pay surrender charges
The guaranteed withdrawal benefit rider allows you to do both, and waives the surrender charges that you would otherwise have to pay on a lump sum withdrawal.The rider comes in two basic variations, a guaranteed lifetime withdrawal benefit (GLWB), and a guaranteed minimum withdrawal benefit (GMWB).
The Guaranteed Lifetime Withdrawal Benefit (GLWB)
The GLWB allows you to make immediate withdrawals from your annuity, without having to annuitize the investment. The remaining funds in the annuity will continue to be invested according to the terms of the original annuity contract. The amount that you can withdraw is determined by a percentage of the value of the annuity contract.
Let's say that you invest $100,000 in an annuity that is to begin making income payments in 10 years. But you decide you need to access some of funds. You have a GLWB rider attached to the annuity, that allows you to withdraw up to 10% per year in a lump sum.
You withdraw $10,000 in a lump sum, and the remaining $90,000 continues to be invested in the plan. In order to keep the income payments consistent with the contract amount, they may be delayed until the end of year 11 or 12, in order to make up for funds distributed in the withdrawal.
Guaranteed Minimum Withdrawal Benefit (GMWB)
This is a variation of the guaranteed withdrawal benefit rider that allows the annuity investor to recoup their initial investment in the plan. It’s designed primarily to protect the annuity owner from loss of investment value do to financial market declines.
A GMWB allows you to withdraw a percentage of your original annuity investment each year, until that investment has been repaid to you in full. Once all of the original investment has been recovered, your entire principal balance has effectively been protected from market swings, because it has been returned to you. The money remaining in the annuity will be comprised entirely of investment gains earned during the principal recovery period.
For example, let's say that you invest $100,000 in an annuity, and you add a GMWB rider to the policy. You withdraw 10% per year – or $10,000 – for 10 years. At that point, you will have recovered your full investment in the annuity. Any funds remaining in the plan are investment gains, which will represent your investment in the annuity going forward.
How the Guaranteed Withdrawal Benefit Works
We’re going to focus on the GLWB version of the rider from here on. There are different ways that the guaranteed withdrawal rider works, depending on the insurance company.
In its most basic form, the guaranteed withdrawal benefit rider gives you at least limited access to lump sum distributions from your annuity, in addition to your annual investment income payments.
If you're taking a deferred annuity, in the hopes that will increase in value, and therefore increase your income payouts, but it instead goes down, the rider will protect your income payments. It can provide you with a minimum withdrawal benefit that is equal to the lower of the current value of your annuity, or your initial investment in the plan.
Let's say that you invest $200,000 in a deferred annuity. After five years, due to market declines, the annuity value is only $150,000. If you selected a 5% annual income payment rate, you will receive $10,000 per year, which is 5% of your original investment. The payment will not be based on 5% of $150,000, since it is lower than your initial investment.
Flipping it around, if we take the same example, except that after five years the value of the annuity increased to $250,000, your annual income payment rate will be applied to that value, since it is higher than your initial investment. Your annual income payments will be $12,500 per year – 5% of $250,000 – instead of $10,000 per year.
Another possible variation is that the rider will enable you to increase your annual income percentage based on your age at the time the income payments begin. The older that you are when you began taking payments, the higher the percentage will be.
For example, the rider may provide that you can begin taking income payments at a rate of 5% per year at age 60. But if you delay the beginning of payments until you turn 65, the payment rate will increase to 6%. At 70 it will increase to 7%, and so on. Since you are delaying the receipt of income payments, the annuity will have more time to build up value to support the higher payment levels. This can be an excellent strategy to increase your income in your later retirement years, when other retirement assets may be drawing down, and providing you with less income.
Step-up Provision. If your guaranteed withdrawal benefit rider has this provision, it will be possible for your income payments to increase in the future. With a step-up provision, the insurance company can increase your income payments based on the current value of your annuity, if it is higher than the original value.
They will perform an evaluation at regular intervals, usually every five or 10 years. If the value is higher, it will increase the payments. If it is lower, they will continue with the original payments.
For example, let's say that you have a $200,000 annuity, with a 5% annual income payment rate, or $10,000 per year. Five years later, the annuity is worth $250,000 due to strong investment performance. If you have the step-up provision, the insurance company will apply the 5% annual payment rate to the $250,000. That will increase your annual income payments to $12,500. That payment level will continue until the next review, at which point it will be either continued (if the value of the annuity is either the same or lower), or it will increase the payment, if the value of the annuity is higher.
Guaranteed Withdrawal Benefit Lump Sum Withdrawals
While a guaranteed withdrawal benefit rider will allow you to take lump sum withdrawals from your annuity, they may reduce subsequent withdrawals. The reduction will be based on the amount that you have already withdrawn from the annuity.
For example, let's say that you set up an annuity for $200,000, with a 5% annual income payment, or $10,000 per year. If you take a 10% withdrawal under the guaranteed withdrawal benefit rider, your annual income payments will drop proportionately.
Since you will have withdrawn $20,000 (10%) under the rider, that will leave $180,000 remaining in your annuity. When your income payments begin, they will be reduced by 10%. That means that instead of receiving $10,000 per year, your income payments will be reduced to $9,000 per year. That's 5% of the remaining $180,000 in the annuity.
Guaranteed Withdrawal Benefit Death Benefit
If you have a guaranteed withdrawal benefit rider, there is also usually an enhanced death benefit.
With annuities, the value of the annuity at the time of your death reverts to the insurance company, not to your heirs. Conversely, if your annuity is depleted while you are still alive, insurance company will continue to make annual income payments to you. The insurance company will use the two scenarios to balance each other out across many annuity investors.
But when you have a guaranteed withdrawal benefit rider, there is also usually a death benefit, even if your annuity has not been fully depleted. Under the rider, the insurance company will typically pay a death benefit to your heirs that is at least equal to the remaining cash value in the annuity. Surrender charges will typically be applied to the amount of the payment however.
Guaranteed Withdrawal Benefit Fees
Since there are many different insurance companies, issuing many different types of annuities, as well as proprietary guaranteed withdrawal benefit riders, the fees that you will pay for adding this rider to your annuity can vary widely.
The fee for the rider is anywhere between 0.1% (one-tenth of 1%) and 1.00% of the annuity's cash value.
The fee is charged through a reduction in the percentage of the annual income payments. For example, if your income payments are scheduled to be 5% of the annuity value, and the guaranteed withdrawal benefit rider fee is 0.50%, your income payments will be reduced to 4.50%.
Why You Might Want to Add a Guaranteed Withdrawal Benefit Rider to Your Annuity
The basic benefit of a guaranteed withdrawal benefit rider is that it will allow you to access at least some of the money from your annuity in a lump sum, while still having the basic advantage of a lifetime income that an annuity provides.
It's certainly worth considering if the fee is reasonable, and you are still able to receive an adequate income flow from your annuity after adding the rider to the annuity.