Four years ago a woman named “Jane” had a problem. She was receiving payments as part of a buyout from her husband’s business. Her dilemma was how to replace the payments she was receiving while also trying to pass as much on to her kids as possible. She was proud of her husband and the business that he created and passed on to their kids. With all the hard work over the years if she wasn’t going to spend the money she wanted to make sure her family got as much as possible.
[As a side note she does have other assets and other income we are going to focus on one account for now]
Jane was about to turn 76. The total sum of money that she had available was $300,000. Her current accounts were $100,000 in a fixed annuity earning around 3.5% with Ameriprise, $120,000 in a few different CDs that were earning 3-4% and $80,000 in some mutual funds that an adviser had put together for her. Are you with me so far?
What She Did
She put the full $300,000 into an AXA Equitable Accumulator, a variable annuity. Then she added a couple of riders to her contract. First she added a GMIB rider and then a death benefit rider. We’ll get to those in a second.
That’s what everyone is thinking about and wondering about so let’s start there. It is an annuity. The basic contract has mortality and expenses associated with it totaling 1.25% per year. The GMIB rider has an expense of 0.65% and the death benefit that she chose has an expense of 0.60%. Getting expensive and we haven’t even added in the investments. The investment expenses range from 0.64% to 3.65%. Jane’s current portfolio is costing her 1.08%. This brings the total charges on her contract to 3.58%.
Death Benefit Rider
The death benefit rider that Jane chose was the greater of 6% roll-up or annual ratchet to age 85. During the first couple of years of the contract she was enjoying the annual ratchet. With the lock-in in 2007 she was left with a death benefit of $380,000. This meant that in 2008 when the market was falling, Jane’s death benefit on this contract was $380,000. It was not subject to investment fluctuations.
Guaranteed Minimum Income Benefit
The GMIB rider that Jane chose gave her a base benefit that would roll-up by 6% per year. She is required to hold the contract for 10 years after which point if she chooses she could annuitize off of the benefit amount regardless of her contract value. For Jane this meant that she would start at $300,000. She will earn 6% net of fees for her benefit amount. So in the first year she would earn 6% of $300,000 or $18,000. In the second year she will earn 6% of $318,000 or $19,080. And so on. Are you still with me?
As we mentioned at the beginning Jane was going to be needing income in 2 years. What this meant was that her account was allowed to do nothing but grow for the first two years. In fact, with the market performance of 2006 and 2007 she found herself with a contract value of $380,000 and her benefit amount was $337,080. Who needs this stinking safety net? But now Jane needed income. The way her GMIB works is that it allows her to take up to the 6% roll-up on her benefit on a dollar-for-dollar basis. This meant that if she takes the 6% as income her benefit amount stays flat. So this is what she did. She took the 6% in the third contract year as monthly income and it came out to approximately $1,685 per month.
Keep in mind that Jane had gains in this variable annuity due to market performance. This was a non-qualified annuity which meant that the gains were taxable as ordinary income. Annuities also follow LIFO which stand for last in, first out. This means that all the gains come out before the contributions. So when she began taking income in 2008 it was fully taxable and subject to a 20% withholding. The checks she received then were for approximately $1,350.
Then 2008 hit. The markets started to crash and they crashed fast. Now because of her safety net, Jane chose to be a little bit more aggressive with this account. She was actually in about a 65/35 splits towards equities. The funny thing is today she has the same 65/35 split. Her account is set to rebalance quarterly. She just might need the safety net now. Are the costs still too high? The upside is that now she no longer has to worry about the taxability of her income since the gains in the account went away pretty quickly in 2008.
Today she continues to receive her income of $1,685 per month. Her account value is $255,000. She started with $300,000 and has withdrawn about $40,000. So it looks like she’s almost even. Then we look at her benefit amount and it is $337,080. Her death benefit was up to $380,000 using the ratchet feature but it has been reduced by the income she has received so today it is $340,000. Remember that as she continues to take income this death benefit cannot fall below her contract benefit amount (the 6% roll-up). One thing not to forget is that she can’t access that benefit amount until one of three things happens: 1. she passes away, 2. her account value drops to zero and 3. her 10th contract year (age 85). This means she continues to receive her $1,685 per month until age 85 at which point she can then annuitize off the benefit amount which the contract estimates to provide $40,000 per year. Not a bad pay raise.
What do you think? Good deal?
**Disclaimer: This is based on a true story. Names have been changed and numbers adjusted slightly to make them more easier to work with. All contract information was taken from the prospectus. This contract is no longer offered.**