Deferred variable annuity – Accumulation rate

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We start with the process of growing the guaranteed benefit base during the deferral or accrual period before distributions begin. This growth is important because it is then used to determine the amount of guaranteed lifetime income provided by the annuity. The deferral period can be skipped if the retiree wants lifetime distributions to begin immediately.

Deferred variable annuities with guaranteed income riders generally allow a guaranteed rate of growth on the benefit basis to be locked in during the accrual period prior to the start of guaranteed distributions, including the ability to set the benefit basis as the point peaking in the contract value of the underlying assets on anniversary dates during the history of the rider. This benefit base is a hypothetical number used to calculate the amount of guaranteed income paid out during the withdrawal phase. It is separate from the contractual value of the assets, which the owner could access based on the actual growth of the account net of fees and redemption fees.

For example, if the accrual rate of the benefit base is 6% compounded annually, the value of the benefit base would double in about twelve years. The benefit basis could be even greater if the contract value increases on the relevant dates when this is verified. Conversely, the actual contract value of the underlying assets will be determined by market performance. After the twelve-year accrual period has elapsed, if the market has underperformed and the value of the benefit base is significantly higher than the contractual value of the underlying assets, then the income guarantee is “in the market”. Classes “. The benefit base is greater than the contract value. In such a case, the owner may wish to continue paying for the rider and receive the guaranteed income calculated on this higher benefit basis.

On the other hand, if the markets have behaved well during these twelve years, the contractual value of the underlying assets may be close to or the same as the value of the benefit base. In this case, the retiree may wonder whether it is worthwhile to start receiving distributions with the guaranteed income, to have the contractual value of the underlying assets returned to an unprotected investment portfolio or to exchange it. against another annuity with better withdrawal possibilities for the value of the contract.

Typically, the benefit base can grow at the higher of a guaranteed accrual rate or the high threshold achieved through the growth of the investment in the contract value for the underlying assets held in the annuity. But the interaction of these two possibilities can be confusing. I will be talking about both rollups and step-ups, which are not interchangeable terms. Stacks are a guaranteed minimum growth rate for the benefit base, and markups are increases for the benefit base triggered when the contract value of the underlying assets in the annuity sub-accounts has increased to a new level. high watermark value. Let’s start with the stacking rate.

What is the guaranteed accumulation rate for the benefit base? Is this a compound rate or a simple rate?

To begin with, we can consider an accumulation rate that applies annually to the anniversary of the contract for the opening of the annuity. If a variable annuity offers a guaranteed compound accrual rate of 5% during the deferral period, then the benefit base supported by a premium of $ 100,000 would increase to $ 127,628 after five years (100,000 x 1.05 ^ 5 ) and $ 162,890 after ten years (100,000 x 1.05 ^ 10).

If it were instead a simple growth rate of 5%, then 5% of the initial premium would be added to the benefit base after each year, which would be $ 125,000 after five years and $ 150,000 after. ten years, for example. The longer the deferral period, the more opportunity a compound stack rate has to move forward, with growth on past growth, versus a simple stack rate on the initial premium. For example, with these numbers provided, we can see that a compound growth rate of 5% would exceed a simple growth rate of 6% after ten years, as the latter would only grow by $ 160,000.

Exhibit 5.1 gives an example of $ 100,000 invested in a variable annuity at age fifty-five that offers a compound annual growth rate of 5% based on benefits. As mentioned, after ten years, the benefit base increased to $ 162,890. If the contractual value of the underlying assets has never exceeded this guaranteed accrual rate when verified at the relevant dates, this would reflect the benefit basis of the annuity.

It should be noted that the guaranteed turnover rate is not a guaranteed return on investment. It does not apply to the contractual value of the assets. It only applies to the benefit base used to calculate guaranteed income amounts. This detail is a constant source of confusion for individuals.

Exhibit 5.1: Guaranteed benefit basis for a premium of $ 100,000 in a deferred variable annuity with a compound annual turnover rate of 5%

When are the accumulations acquired in the benefit base?

Most often, the accrual rate is applied annually on the anniversary date of the entry into force of the contract, and it is also at this time that the benefit base would vest at the new higher value. This is the case illustrated in Exhibit 5.1.

Some variable annuities will apply accruals more frequently, such as daily, monthly or quarterly. With compounding, more frequent stacking can provide an advantage, as interest is more likely to accrue on interest. However, the question remains as to when the rollups will be acquired. More frequent accruals may still not be acquired until the anniversary date of the contract. The only reason this could be a problem is that someone is looking to start distributions in the middle of the year. Even if the accumulations are more frequent, if they are not acquired until the anniversary date, the benefit base will not be even higher when calculating the income guarantee. Withdrawals before the anniversary date would not take into account the potential growth for the year.

This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon

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