Consider Michael Kitces as the thinking man’s financial planner. He’s smart. He’s prolific. And he spends his best hours where the rubber meets the road, in the analysis of the actual financial products most of us encounter in real life. The results can be surprising.
Here’s an example: Suppose you are one of the millions of people who took advantage of an offer for a free dinner — and ended up buying “living benefits.”
You’re probably thinking you got a really good deal. Your insurance contract defers any taxable income for 10 years. It also guarantees to nearly double what you may withdraw annually over what you could take today after those 10 years. Better still, no matter what the market does to your actual investment over the next decade — or in the many years beyond that — the annual payment is guaranteed for life. It is guaranteed even if the cash value of your investment disappears.
What’s not to like?
His answer: Delay.
“In the end,” he writes on his blog, “most retirees with a GLWB (Guaranteed Lifetime Withdrawal Benefit) rider will do little more than pay a lot in annuity costs to receive a guarantee to just spend their own original contributions and nothing more.”
This is not something you will be told by your friendly free-dinner salesperson. Nor will that salesperson have figured out what Mr. Kitces has figured out. If you’ve already got one of these things, the best way to make it a better deal is to take the living benefits now. Yesterday would be still better.
You can understand this, Kitces argues, by thinking about when you are benefiting from your money. Suppose you are a 55-year-old single woman who wants to secure an income at age 65. You invest $100,000 in the variable annuity with a GLWB rider. The contract provides a 5 percent withdrawal against a benefit base guaranteed to double in 10 years.
That’s pretty nice: In 10 years your $100,000 will be delivering a lifetime guaranteed income of $10,000 a year — more if your actual investment does more than double. But no less if your investment disappoints.
So what actually happens?
First, you get no money for 10 years. Then, you get your money back at $10,000 a year. In a good case, your actual money has grown to $200,000 and it will take an additional 20 years before you are getting any money that wasn’t yours already. So you’ve got to hang in for a total of 30 years before you’re getting anything but your own money back.
In a more likely case, one where your money earns an after-fees net of 4 percent a year, you’ll be drawing that $10,000 a year against an actual cash value of $148,000 — so it will take you nearly 15 years, a total of 25 years, before you are getting anything back beyond your original investment and early account earnings.
When you consider a 25- to 30-year period, there is a fair chance — call it 50 percent — that the same woman will die. Kitces uses Social Security life expectancy figures, which make the odds worse.
While you’re getting nothing, the insurance company is collecting about 3 percent for its living benefit guarantee and other insurance contract fees. It may be getting about another 1 percent in mutual fund fees for managing the actual money. So the insurance company gets about 4 percent a year from your money while you’re getting nothing. It also keeps getting it until the moment your investment is exhausted. To be sure, there is risk here for the insurance company. But it is well rewarded.
Kitces’ insight here is that to delay taking those living benefits is the same as making a losing bet against the ever-increasing probability of death. So, how do you collect the most from the contract? He suggests, with caveats, that people start taking their living benefits immediately.
And what if you don’t need the money? No problem, he says. Reinvest it. You’ll have a guaranteed income. You’ll have it for longer since you’ll start taking it younger. And if you don’t need the income, you can use the cash to rebuild your nest egg in an investment medium that has much lower management costs.
SCOTT BURNS is a principal of Plano-based investment firm AssetBuilder Inc. His e-mail address is scott@scottburns.com.
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