I am looking to retire soon. I am seeking monthly income I cannot outlive, but have trouble making sense of the varied options available. I recently heard about a retirement funding vehicle that offers access to funds, and a monthly income payment that increases as the market goes up, but does not come down if the market does. Could this be as good as it sounds?
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Director and Actuary
Actuarial Consulting Services, TIAA-CREF
That depends on your individual situation. With that in mind, here is some information that may help demonstrate how some of these offers work.
Know how the fund works
The product you heard about may be a variable annuity with a Guaranteed Minimum Withdrawal Benefit (GMWB) rider.
Variable annuities are long-term investments designed for retirement funding and are subject to market fluctuations and investment risks, including possible loss of principal. They are also subject to fees and expenses that may exceed those of other investments.
The GMWB feature is an optional rider for an additional charge and offers a you the ability to withdraw a certain percentage of your initial investment amount (such as 5 percent) each year, broken into monthly payments, which can ratchet upwards if market performance is good, but will not decline even if the market performs poorly.
While these can be attractive features and a GMWB may be appropriate for certain investors, there are some potential drawbacks.
Added protection may come at the expense of your income
Riders, such as the GMWB or the guaranteed period, can offer protection, but at additional expense. Because of the way these fees add up over time, it may be worth deciding how important added protection is for your investment. You want to build and protect retirement assets in a way that has the greatest potential to be cost-effective, so look for protected investments with lower fees.
As retirement planning starts to account for longer and longer retirements, it's important to take into account long-term market activities when planning your portfolio. Some protective riders may guard against a market downturn, but may inhibit an investment from enjoying upturns should the market recover.
Consider the advantages of a Life Annuity
Life annuities issued by the Teachers Insurance and Annuity Association of America (TIAA), for example, provide income that lasts as long as the policyholder, or his or her spouse or partner, are alive.1 Life annuities pay income as long as either the annuitant or the second annuitant is alive or until the end of an optional specified guaranteed period,2 whichever is longer, and which, after the death of an annuitant, continues at either the same or a reduced level for the life of the other annuitant.
Life annuities can come with an optional rider, for an additional charge, known as a guaranteed period, which can assure the buyer that the estate can receive assets upon early death and offer protection beyond lifetime income. In addition, if you want to invest in equities markets, variable life annuities have an important advantage, which is that they have historically produced strong results. Furthermore, TIAA-CREF variable annuity accounts have fees that are among the lowest in the industry,3 keeping more of your money invested and working for you.
Make your investment work efficiently
Below is a hypothetical graph comparing the differences in guaranteed income for an individual, age 65, who retired in 1983 and invested $100,000 in either a life annuity or a 5 percent guaranteed minimum withdrawal product. Keep in mind, past performance is no guarantee of future results. Note that there are material differences including limitations and restrictions between the two income options and based upon your personal situation one may be advantageous over the other. Be sure to consult professional, objective advisors about account and rider fees, fees accompanying underlying investments, as well as any withdrawal charges. Please note that TIAA-CREF does not offer a GMWB as an income option.
Exhibit 1: Single Life Annuity vs. Guaranteed Minimum Withdrawal Benefit4
As Exhibit 1 demonstrates, the 5 percent GMWB would not have reacted as efficiently to market increases as the annuity did throughout the 1980s and 1990s. Also note that for the year 2000 the life annuity would have paid out over $19,000 more than the GMWB from the same original $100,000 investment.
While the GMWB payment remained steady during the market declines in the early part of this century, during that time the total account balance was decreasing even if the payments were not. This would have made it much more difficult for the GMWB to recover when the market went back up.
Like any conservative investment strategy, the GMWB minimizes both risk and reward.
While the GMWB may appear attractive in times of market volatility, remember that retirement income options are long-term investments. It would be unwise to base a 25-year investment plan on a few months' performance.
Because a life annuity can react efficiently to market increases, it may be a more useful vehicle for maximizing retirement income. And, with a guaranteed period, it can be a low risk investment.
Because a life annuity is a product you purchase, rather than invest in, there is no 'account balance.' Instead, the column on the far right of the chart is for hypothetical comparison only, calculated by subtracting the GMWB annual payment from the life annuity annual payment and reinvesting the difference in the CREF Stock Account. For instance, in 1983 you would subtract $5,000 from $6,646, and reinvest the difference ($1,646) in CREF Stock at 1983's CREF Stock account's rate of return, and end up with a balance of $2,059 in the 'excess benefit' account.
This figure can act as an accurate comparison to the GMWB account balance, as both show the amount available to the beneficiary should the annuitant die. If the annuitant who purchased the GMWB died in 2007, they would pass $420,328 on to their beneficiary, while if the annuitant who purchased the life annuity died in 2007 (had they utilized the strategy of investing the 'excess benefit') would pass on $568,776 — a difference of over $140,000 coming from the same $100,000 original investment — while having enjoyed annual payments equal to that of the GMWB.
Further, for the sake of comparing concepts, we assumed the fees for the GMWB product and the life annuity were equal (around 40-55 basis points). However, some GMWB products may have substantially higher fees. Had we incorporated the higher fees — for example, 65 basis points in addition to the historical CREF Stock fees — in our hypothetical calculations, the GMWB product's accumulation at the end of 2007 would be $80,000 lower than it is on the chart. The GMWB annual payment over the years would have been lower as well.
As shown, the life annuity can allow you either to enjoy higher annual payments than the GMWB, or equal annual payments with a potential to more efficiently grow your assets.
Because individual situations vary, you should always seek professional, objective advice before considering your investment options.
As you mentioned, some contracts tout the flexibility to withdraw income in steady increments without eroding principal. This may be fine, assuming that you will only be withdrawing the guaranteed percentage each year. You should be aware, however, that if you need to withdraw in excess of that percentage, you will begin to deplete principal which will affect your future income. Additionally you may incur surrender charges and a 10 percent federal tax penalty on earnings if you are under age 59 1/2. Therefore, if you wish to have both access to your funds on an as-needed basis and a steady stream of income, you should carefully evaluate whether this option would be as advantageous for your particular situation as it might first appear.
A diverse retirement portfolio can give you both flexibility and income
If you believe you may require ready access to additional funds, an alternative approach might be to combine a life annuity with other investments. For example, there may be a long-term advantage to reinvesting part of your yearly life annuity payment. Because a life annuity, in order to guarantee lifetime income, does not allow immediate access to funds, another effective strategy may be to invest part of your retirement assets in a life annuity and keep part in a more liquid investment, such as a lifecycle or mutual fund. It is important to note that, unlike an annuity, a mutual fund does not guarantee principal or income.
Consider diversifying your retirement portfolio
The Retirement Income Fund offered by TIAA-CREF is designed to provide high total return over time primarily through income, while maintaining a secondary emphasis on capital appreciation. The Fund, from which investors may withdraw assets at any time, complements guaranteed retirement income vehicles such as annuities or systematic withdrawals from an IRA or other accounts.
When combined with such retirement income vehicles as a low-cost annuity, the Retirement Income Fund can enable you to create both a foundation of guaranteed income you cannot outlive (through the life annuity) and the ability to convert your assets to cash as needed with the mutual fund. The Fund's annual net expense ratio (for the Retirement Class), 0.61 percent of net assets, is among the lowest in the financial industry.
By keeping ready money and guaranteed income for life separate, but as part of one retirement portfolio, you may be able take advantage of both without one adversely affecting the other.
Consider investing in both a Life Annuity and a Retirement Income Fund – It's a combination that can provide both the access and income you want and need throughout retirement.5
Investment products are not FDIC insured, may lose value and are not bank guaranteed.
You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877 518-9161 or log on to www.tiaa-cref.org for a prospectus that contains this and other information. Please read the prospectus carefully before investing.
Annuity products are issued by TIAA (Teachers Insurance and Annuity Association), New York, NY. TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., members FINRA, distribute securities products.
1 Annuity guarantees are based on the claims paying ability of the issuing insurance company.
2 You can elect a guaranteed period of 10, 15 or 20 years.
3 Morningstar Direct (February 2008) based on Morningstar expense comparisons by category.
4 Returns based on the CREF Stock variable annuity account, a broadly diversified portfolio of common stocks. Assumed $100,000 accumulation. Annuity is at age 65, Single Life A2000, (2-year setback), 4 percent AIR. Life annuity shown after CREF Stock expenses, hypothetical GMWB product shown after expenses, assumed to equal historical CREF Stock expenses over the same period (approximately .40 percent-.55 percent a year).
5 Please keep in mind that there are risks associated with investing in securities including loss of principal.