Annuity options: Choices abound for today's retiree

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As the earliest baby boomers begin to enter retirement, the various income guarantees and other living benefits offered through variable annuities (VAs) are gaining importance.
Yet before you rush to add a VA to your retirement funding scheme, take some time to understand what VAs have to offer in a general sense, and to sort through the host of optional features and their associated fees and investment risks.

Variable annuities — A brief primer

The Securities and Exchange Commission defines a VA as "a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date."Footnote 1 You can purchase a VA by making a single purchase payment or a series of payments spread out over a period of time.
The "variable" modifier denotes that the value of your VA will vary depending on the performance of the underlying investments you choose when contributing to and managing your account. Most VAs offer a menu of subaccounts that, similar to defined contribution plan options, invest in different styles of stocks, bonds, and money market instruments.Footnote 2 Therefore, VAs could lose value.
VAs are used mainly to supplement more traditional sources of retirement income such as Social Security and pension plans. Common features include:
  • Tax-deferred growth. You will pay no taxes on the earnings from your annuity investments until you begin making withdrawals or receiving periodic payments.Footnote 3
  • Unlimited contributions. Generally speaking, there is no limit to the amount of money you can put into a VA.
  • No mandatory withdrawals. If your VA is not part of an IRA or a qualified retirement plan, you are not required to begin taking minimum distributions after age 72.Footnote 4, 5
  • Death benefit. If you die prior to annuitizing your contract — that is, converting VA into regular income payments — your beneficiary will receive, in general, an amount at least as much as you contributed in payments, less any withdrawals.
  • Lifetime income benefits. Annuity holders typically have several options for receiving annuity payments for the rest of your life, including the choice of continuing payments to the beneficiaries for a set period of time.

Living benefit options — Driving today's annuity market

Although the distinguishing characteristic of an annuity is stream of income that cannot be outlived, most VAs offer — for an additional fee — optional principal protection benefits. Referred to collectively as living benefits, they offer exposure to the market's upside while protecting against the effects of market declines on your account value or future income.Footnote 5
There are three basic types of living benefits.
  • Guaranteed lifetime withdrawal benefit (GLWB). This benefit guarantees a return of your purchase payments (less prior withdrawals) through annual withdrawals for a specified period or for life.
  • Guaranteed minimum income benefit (GMIB). This benefit guarantees a minimum future income level regardless of how the market performs
  • Guaranteed minimum accumulation benefit (GMAB). This benefit ensures that you retain the value of your purchase payments regardless of investment performance.
Living benefit basics
Guaranteed Lifetime Withdrawal Benefit (GLWB)Guaranteed Minimum Income Benefit (GMIB)Guaranteed Minimum Accumulation Benefit (GMAB)
Benefit calculationPayout is either a pre-set percentage of your net purchase payments (and any applicable step-ups), typically around 4% per year, or is based on life expectancyPayout is based on the greater of your account value or your net purchase payments (and any applicable step-ups) at the time you annuitizeIf your contract value is worth less than your net purchase payments (and any applicable step-ups) on a pre-set date, the insurer will make up the difference
AnnuitizationNot requiredLong term, typically 10 yearsLong term, typically 10 years
Duration of benefitLifetime payments, if withdrawals stay within prescribed parametersLifetime income guaranteeOne-time, yet can be renewed
Potential usesInvestors who seek equity exposure for growth potential, but also have a need for liquidity in the short termInvestors who seek long-term growth potential, have no immediate need for liquidity, but want to guarantee a future stream of incomeInvestors who seek long-term exposure to the market's upside potential as well as principal protection and/or minimum future income
In practice, living benefits have evolved increasingly into new hybrid benefit options, offering a mix of guarantees and participation in the market's potential upside, as insurance companies seek ways to differentiate their offerings in the marketplace. This environment of expanding flexibility and functionality is helping to redefine VAs for a new generation of retirement investors. But with added choice comes the possibility for confusion and the need for advice and guidance.

Footnote 1 Source: Securities and Exchange Commission. Variable Annuities: What You Should Know, last modified April 18, 2011.

Footnote 2 An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

Footnote 3 Withdrawals are taxable as ordinary income to the extent of gain, and if made prior to age 59½, may also be subject to a 10% additional tax. Please refer to your contract or prospectus for detailed information about how withdrawals can affect your annuity's death benefit and/or your living benefit.

Footnote 4 This applies to nonqualified annuities only. Qualified annuities (i.e., rollovers) must adhere to required minimum distribution rules.

Footnote 5 Investors do not receive any additional tax benefit by placing qualified retirement plan assets into an annuity, since tax deferral is already provided by the qualified plan. However, an annuity may still be an attractive option if other features such as guaranteed riders and death benefits are important to the investor.

Footnote 6 All living benefits are available for an additional cost. The guarantees associated with living benefits are backed by the claims-paying ability of the issuing insurance company. It is important to weigh the costs against the benefits when adding such options to an annuity contract.

Variable annuities are long-term, tax-deferred investment vehicles designed for retirement purposes and contain both an investment and insurance component. They are sold only by prospectus. Guarantees are based on the claims-paying ability of the issuer and do not apply to a variable annuity's separate account or its underlying investments. The investment returns and principal value of the available subaccount portfolios will fluctuate so that the value of an investor's unit, when redeemed, may be worth more or less than their original value. Withdrawals made prior to age 59½ may be subject to a 10% additional tax. Surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal.

All annuity contract and rider guarantees, including optional benefits and any fixed subaccount crediting rates or annuity payout rates, are backed by the claims-paying ability of the issuing insurance company. They are not backed by Merrill Lynch or its affiliates, nor do Merrill Lynch or its affiliates make any representations or guarantees regarding the claims-paying ability of the issuing insurance company.

Not FDIC/NCUA Insured -- May Lose Value -- Not Bank/CU Guaranteed -- Not a Deposit -- Not Insured by Any Federal Agency

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The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.

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