Berko: Annuities and GMIB
Thursday, July 31, 2014 6:00 AM
Dear Mr. Berko:
I’m considering putting $100,000 into an Allianz variable annuity. Please explain how the guaranteed minimum income benefit works. And please tell me which of the 30 mutual funds available in this High Five annuity I should invest in. I don’t want to be taken to the cleaners. Is this a good 10-year investment for someone who is 56?
C.D., Vancouver, Wash.
I’m suspect of any investment calling itself High Five and then giving you a short, 100-page prospectus so bloody boring that by comparison, reading a New York City phone book would be a hilarious experience. Allianz is a French company. Beware of the frog eaters residing across the pond; they guide their economic lives by a different set of principles than Americans do. However, Allianz is a respected insurer, and with the exception of some disappointing unilateral changes in its annuity policies during the past few years, it is an honorable company.
The guaranteed minimum income benefit (GMIB) portion is your safety net. The annuity company promises to credit your original $100,000 investment with an annual fixed interest rate as long as you own the annuity. Most companies guarantee to pay 5 percent (some pay more) each year to your GMIB account. Even if the mutual funds (insurers insist you call them subaccounts) perform poorly, as many do, the 5 percent guaranteed rate is always credited to your GMIB; that is, unless the insurer changes horses in midstream. And insurers have, and they can, and when they do, things can get pretty rough. But this accumulation isn’t a value that you can take to the bank in 10 years; rather, the annuity allows you to take a fixed withdrawal from the GMIB over the remaining years of your life.
Assume you invest $100,000 in an annuity with a 5 percent income guarantee. Be mindful that most mutual funds offered by annuities have been scrubbed to reduce volatility that might be harmful to the insurer’s future liabilities. Allianz, like many annuity companies, runs its own proprietary mutual funds with placid, passive and pablum portfolios. So it’s wise to assume the worst: that those Allianz mutual funds have been scrubbed so clean that your $100,000 annuity grows to $65,000 in 10 years after you pay those enormous annual fees plus management costs and mortality expenses. However, all is not lost, because that $100,000 investment has compounded at 5 percent annually in that time frame, so your GMIB is now $163,000. And because you are 66, you can turn this into an income stream of $8,150 for the rest of your life or until you move to Jupiter or Mars.
You now have a short, bare-bones explanation of the GMIB, which your salesperson clearly did not give you. But here’s a question annuity owners should ask: Is the 5 percent interest on your original investment add-on interest or compounded? If it’s add-on (some annuities hide this feature), your GMIB will be worth only $150,000 in 10 years rather than $163,000. While the Allianz rate is compounded, the failure to ask this simple question of other annuities could be costly. You know, of course, that all income and gains (LOL) accumulate tax-deferred, but you’ll pay taxes at ordinary rates when you take the money out.
When someone buys an annuity, I recommend investing the entire caboodle in the riskiest and most aggressive mutual funds the annuity offers. You have nothing to lose because it’s insured if you hold it for 10 years, and you have the GMIB accumulating at 5 percent each year. However, among the 30 funds in the Allianz selection, I couldn’t find a single fund with a performance record beyond 2007 – and most reached back to only 2008. The fund choices in the Allianz product are disgustingly plain vanilla. Did you know that 2 percent of mutual funds have 10-year performance records of over 10 percent and not one of them is an Allianz fund? The yearly fees to own an annuity average 3.5 percent. So if High Five were to average 7.5 percent a year in stock market gains, which is very doubtful, then your return would be just 4 percent annually. And yippee doodle dandy, you’ve been taken to the cleaners, Clyde.
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