Monday, December 12, 2011

GLWBs: Retiree Protection or Money Illusion?

My second column for Advisor Perspectives, "GLWBs: Retiree Protection or Money Illusions?" is now available. Of course, having a guaranteed income for life is a very desirable goal for retirees. But I'm concerned whether the guarantees made by these retirement products will really be all that helpful, since they are not adjusted for inflation. I thought that the illustration Vanguard uses on page 5 of their brochure (accessible through the link below after you tell them your state) was rather misleading in that by using July 31, 1996, as the start date, they just might have cherry-picked the best possible moment in history to illustrate how GLWBs provide both growth potential and then market protection.  Looking back at the historical record, events will rarely make GLWBs appear so attractive.

This is not to say that GLWBs are a completely bad idea. I do understand that they are a form of insurance, not an investment, and generally we do not want our insurance to pay off. But in simulating the performance of GLWBs with historical data, I observe that financial markets would have to get significantly worse than they've ever been, and/or we would have to live for a significantly long time before there is ever a chance for the GLWB guarantees to kick in. Though I haven't done a proper actuarial study of the value of the GLWB rider, what I have done is enough to convince me that a 0.95% annual rider on the total withdrawal base (which may be more than the remaining account value) is an awful lot to pay for this guarantee.  There's got to be a better way to get guaranteed income for retirees, and that is something I hope to keep exploring in future columns.

As GLWBs are a new topic for me, I needed to do lots of background reading to get up to speed on how they work.  Below are the references I consulted to learn about GLWBs:
Bernicke, Ty A. "Variable Annuities: From Controversial to Mainstream Using a Two-Bucket Strategy, Part 1." Journal of Financial Planning 20, 8 (August).

Bernicke, Ty A. "Variable Annuities: From Controversial to Mainstream Using a Two-Bucket Strategy, Part 2." Journal of Financial Planning 20, 9 (September).

Benedick, Peter. 2011. "Vanguard's GLWB: Credit to Vanguard for Delivering on the Promise."

Blanchett, David. 2011. "The Expected Value of a Guaranteed Minimum Withdrawal Benefit (GMWB) Annuity Rider." Journal of Financial Planning 24, 7 (July): 52-61.

Chen, Peng. "The Real Flaws - A Response to 'Understanding Variable Annuities with GMWBs'." Advisor Perspectives (March 1).

Heubscher, Robert. 2011. "Understanding Variable Annuities with GMWBs (and the flaw in Ibbotson's analysis)." Advisor Perspectives (March 1).  

Tomlinson, Joseph A. 2011. "Income Choices." Financial Planning (May 1).

Tomlinson, Joseph A. 2009. "Thoughts on the Future of Retirement Income Products." Retirement Income Journal (December 16).

Vanguard's GLWB Marketing Literature

Veres, Bob. 2008. "Cheerleaders in Lab Coats." Financial Planning (May 1).

Xiong, James X., Thomas Idzorek, and Peng Chen. 2010. "Allocation to Deferred Variable Annuities with GMWB for Life." Journal of Financial Planning 23, 2 (February): 42-50.


  1. Wade --

    Love the way your column for Advisor Perspectives exposes the omission of inflation in those, er, products.

    Dick Purcell

  2. Thanks Dick!

    I'm starting to use the word "product" now. It was just during my recent trip to Boston that I became cognizant of this term. I found it really unsettling at first. I guess I would have said retirement income strategies, or something like that. I didn't really think of them as products to be sold, like Big Macs or Coca-Cola, but that's the reality for the companies providing them.

  3. Would it not be a valid analysis to simply price the 'normal' annuity, the inflation-adjusted annuity and the variable annuity. Eg.

    No inflation protection gets you 7%.
    Inflation (within limits) protections gets you 4%.
    The variable annuity gives you 5% with the upside possibility of keeping up.

    That makes the tradeoff of risks a subjective judgement that is just as valid as historical data.

    Of course people may make the wrong trade off because they think stocks 'hedge' inflation, when really only stocks' dividends kept up in the 1970's. The stock prices fell because of higher discount rates being used.

  4. Thank you: that sounds like a quite reasonable suggestion to me. GLWB payouts will end up somewhere in between the inflation-adjusted and nominal annuities (or, sometimes, can be even higher than the inflation-adjusted annuity when markets do really well) and this comparison would give a good idea about how the insurance company compares the tradeoffs. GLWBs are also nice, again, because any remaining account balance can be returned.