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A guaranteed minimum income benefit, or GMIB, is an optional rider added to an annuity contract to offer protection against market volatility and ensure income in retirement. It is often added to variable annuities because these financial products contain underlying investments susceptible to market risk.
A guaranteed minimum income benefit is a specific type of annuity rider. Riders are additions to your annuity contract that ensure your financial goals are met.
For an extra cost, riders can strengthen your contract through various provisions.
With a GMIB, the insurance company essentially promises to keep sending you checks, even if you withdraw all the money from your contract. A GMIB rider circumvents the common fear of running out of money in retirement.
GMIBs: Most Often Used For Variable and Indexed Annuities
To better understand a guaranteed minimum income benefit, it’s important to first understand variable annuities. GMIB riders are most often associated with this annuity type.
A variable annuity is a tax-deferred insurance product that pays benefits to the contract holder over a specified number of years. To purchase a variable annuity, you pay a premium to an insurance company. You select the subaccounts to which you want your money allocated. This collection of investment vehicles makes up the annuity’s underlying portfolio, and it has the potential to increase the value of your contract.
Variable and indexed annuities contain underlying investments, usually stocks, bonds, mutual funds or low-cost index funds.
The period during which your money is held by the insurance company and earns interest is known as the accumulation phase. The accumulation phase normally lasts seven to 10 years.
Once the accumulation phase is over, your investment is converted into a stream of periodic income payments, similar to a pension. The size of these pension-like payments is based, in part, on how the underlying investments performed over the years.
In other words, variable annuities expose your premium to market risk.
You may be interested in a variable annuity because they can offer higher payouts in well-performing markets. But, when times are tough and the market declines, so, too, can the value of your variable annuity.
Guaranteed minimum income benefit riders provide protection against this risk. As the name implies, a GMIB rider sets a guaranteed dollar amount of your payout from the insurance company — regardless of the annuity’s investment performance.
How Does a GMIB Rider Work?
An annuity with a GMIB rider has two different values.
The first is the actual market value, described earlier, which is based on the performance of the annuity’s underlying investment portfolio. The second is the GMIB account itself.
Unlike the value of the annuity, which can fluctuate according to the market, the GMIB value increases based on a compounded annual rate, usually between 4 and 7 percent, according to the U.S. Securities and Exchange Commission.
This annual guaranteed percentage is credited to the separate GMIB account each year until you reach a certain age, at which point its value is frozen.
A guaranteed minimum income benefit rider can be customized, like so many other aspects of your annuity contract.
Here is one example of how it can work.
Suppose you purchased $100,000 variable annuity with a GMIB rider. You agree to a compounding rate of 6 percent. You also agree to begin receiving payouts from the insurance company in 10 years, at which point, regardless of the value of your annuity contract, the insurance company begins sending you regular payments for the rest of your life.
Let’s assume that during the 10-year accumulation phase, the market did not perform as you had hoped, and netted only a 5 percent annual return on your original $100,000 premium. Thus, the market value of your variable annuity is now only $162,889.
Your payout will be based on either the market value of your annuity or the value of the GMIB account, whichever is greater. This is always the case with guaranteed minimum income benefits.
Because you purchased a GMIB rider, your payout will be based on the GMIB account value of $179,084, which compounded at 6 percent — as opposed to the 5 percent annual return on the base annuity — and, thus, is higher than the value of the annuity.
Some GMIB riders may also guarantee an annuity payout based on the highest value your investment account ever reached. This is referred to as the high-water mark.
You can’t withdraw and walk away with the full value of the GMIB, but it’s there as a guarantee that if you outlive your money, the insurance company will continue to pay you.
How Much Money Will I Actually Receive Each Year?
Riders tend to pay off more as you grow older.
Insurance companies use what’s known as a payout factor to determine how much money you receive from your annuity each year.
Just because the accumulation phase for a variable annuity lasts 10 years doesn’t mean you must immediately begin receiving payments. In fact, the longer you wait, the higher your monthly payments will be.
Think of our earlier example. The amount of money the insurance company pays is based on the value of the GMIB account. Why? Because at $179,084, its value is larger than the market value of the annuity.
If you start receiving payments between the ages of 59 and 64, an insurance company may give you 4 percent of your GMIB value each year. So, in this example, 4 percent of $179,084 is about $7,163 a year before fees and taxes.
But, if you wait until you’re 65 to 79 years old, an insurance company may offer you 5 percent of the GMIB value each year. This would equal $8,954 a year before fees and taxes.
While a GMIB can offer a higher payout if the value of your annuity decreases, it’s worth noting that nearly all riders have additional fees.
Riders are generally paid for by an automatic transfer of funds from the principal investment to the rider account each year. The rider charge is usually around 1 percent annually. Some fixed index annuities have zero annual fees for a rider, while some variable annuities have income rider fees as high as 1.5 percent.
While GMIBs and other riders are designed to enhance your contract, they do add complexity and cost. Fees associated with a GMIB may eat into the investment growth of your variable or indexed annuity.
A broad range of GMIB riders exist, and each comes with its own unique features and benefits. This can make it difficult to adequately compare options from one insurance company to another.
Finally, there may be age limits for this rider.
Identifying a Good GMIB
Not all GMIB riders are created equal. It’s important to evaluate the specific features and benefits they offer to determine if adding a GMIB is right for you.
- A high guaranteed compounding value (6 percent or higher, ideally)
- Worst case scenario, this percentage earns compounding interest on your initial lump sum even if your variable annuity decreases in value due to market conditions. So, the higher the guaranteed percentage, the better.
- Rider fees
- Adding a rider to your contract can be a smart decision, but make sure fees and other costs don’t devour returns and the value of the guarantee.
- A plan that grows with you
- It’s always beneficial if the GMIB permits your rider to continue growing and compounding interest until at least age 85.
As with all financial products, purchasing a GMIB rider should be part of a solid financial strategy. If you’re unsure of yours, talk to a financial advisor about your long-term goals, including your retirement plans and your intention to leave a legacy for surviving family members upon your death.
A trusted professional can help you determine if a GMIB meets your needs.
5 Cited Research Articles
- Kitces, M. (2013, April 10). Strategies For Existing Variable Annuities With GLWB Or GMIB Riders. Retrieved from https://www.kitces.com/blog/strategies-for-existing-variable-annuities-with-glwb-or-gmib-riders/
- Lankford, K. (2009, April 23). Annuities With Guaranteed Benefits. Retrieved from https://www.kiplinger.com/article/retirement/T003-C000-S001-annuities-with-guaranteed-benefits.html
- Marshall, C., Hardy, M. & Saunders, D. (2010). Valuation of a Guaranteed Minimum Income Benefit. Retrieved from https://www.researchgate.net/publication/228463472_Valuation_of_a_Guaranteed_Minimum_Income_Benefit
- Patton, M. (2015, January 2). Under the Hood: What You Need to Know About Annuities With GMIB Riders. Retrieved from https://www.thinkadvisor.com/2015/01/02/under-the-hood-what-you-need-to-know-about-annuiti/
- U.S. Securities and Exchange Commission. (2012, November 15). MassMutual to Pay $1.625 Million after SEC Investigation Highlights Prior Insufficient Disclosures about Annuity Product. Retrieved from https://www.sec.gov/news/press-release/2012-2012-230htm