In Pensionize Your Nest Egg (my review is available here), authors Moshe Milevsky and Alexandra Macqueen argue that retirees should diversify their income across three product silos: annuities, systematic withdrawal plan (SWP) accounts (that hold traditional stocks and bonds) and guaranteed minimum withdrawal benefit (GMWB) products.

Investors have access to plenty of low-cost products when it comes to annuities and traditional stocks and bonds. But that’s not true of GMWB products such as Manulife’s IncomePlus in existence today. These products have two significant drawbacks: (1) High fees and (2) No inflation protection on the withdrawal benefits.

GMWB products charge annual fees that average 3.5 to 4.1 percent depending on the bells and whistles added to the base model. Most of these products also limit the equity exposure in the fund to 70 to 80 percent. The high fees combined with capped equity exposure reduces the odds of the investment resetting at a higher level than the base. So, investors in GMWBs available today are essentially purchasing an annuity without any inflation protection. A period of sustained high inflation in future can easily eat away the purchasing power of the guaranteed income from a GMWB.

Due to these drawbacks, it should be asked if GMWBs even have a role in a retiree’s portfolio. Wouldn’t a retiree achieve better results from purchasing annuities with a portion of the capital and investing the rest in equities?

This article has 38 comments

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  2. A related subject is an area that I had scratched my head over… Most of us who are still working and contributing to our RSPs don’t even stop to think about how the heck we’re going to get that money out of our accounts after we hit retirement. Assuming we retire at 65, we only have 6 years to take cash out before we hit the magic 71 figure, where the cash either has to be completely out, or else rolled into a RRIF.

    So, if you even manage to save up the $1 million portfolio that everybody wants, you’ll get hit really hard on the taxes upon withdrawal, because you’ll likely be well into the marginal tax bracket if you take out lump sums of money.

    TFSAs, I guess, take a little of the pressure off of that if you divert some cash to that investment vehicle. But at only $5K/yr, it’s a small piece of the puzzle – maybe in 20 yrs it will be large enough to be a viable alternative. But in 20 yrs, it may be too little too late for many of us.

  3. Phil, how many people take their RRSP out in a lump sum and don’t just roll it in to an RRIF though?

  4. Phil, you need to research RRIF accounts. I don’t think they are what you think they are.

    As for GMWB products, I agree with CC. If the fees were low enough, then they might be a worthwhile “silo”, but in practice – not such a great idea.

  5. I haven’t read the book yet, and I was quite surprised to read an apparent endorsement of Manulife’s IncomePlus in the reviews of this book. I can believe that a sensibly-priced product of this type could make sense, but I’m not aware of any sensibly-prices versions.

  6. Also, just another small note phil is how many people actually max out their RRSP contributions so often that they would need to overflow in to a TFSA? Another question is how many people consider 5K a small amount to be able to store away for tax free growth? As a follow up to that, how many income earners have maxed out their TFSA room? I think you may be arguing that it’s not as useful for people in the top 5% income group . . . but wasn’t the point of the accounts to help average Canadians?

  7. Being what I consider to be an average Canadian (certainly not in the top 5% income group, as my household income is less than half the city’s average where I live), I maxed out my TFSA room the first year it opened, and for me it makes more sense to put money there than an RRSP because I am in a lower tax bracket than I will be in future years (I just graduated Univ, and have a lot of unused education credits to bring my tax liability to near zero).

    Once I start paying tax, then RRSPs become attractive, but until then, I’ll max out my TFSA room, and not worry about taxation on that money decades from now. This is of course assuming that future governments don’t change the taxation rules on these accounts.

    As for the subject of the post, and recognizing that I have not read the new book, my understanding is that GMWBs are not intended to be included in a retirees ‘product allocation’ for the purpose of an inflation hedge. As I understand it, annuities are purchased to provide a specified income for a specified time. What happens if you put your entire nest egg into an annutiy, then outlive that period of time? Not only has your purchasing power been eroded by inflation, but you may be left with no income, and more life to live than you planned for. GMWBs will always provide an income, no matter how long you live, as your longevity risk is essentially transferred to the insurance company, it makes sense that these products will not be cheap. Any time you are paying someone else to take risk on your behalf, it’s going to cost you (fixed rate mortgages, anyone?). Equities and other market securities are also included in the plan in order to provide an inflation hedge, as neither of the other products do (though there may be some inflation adjusting annuities, but again, transferring risk to someone else will cost you).

    As I understand it, the products discussed in the book (Moshe has a similar discussion in ‘Your Money Milestones”) are each intended to address risks unique to the retiree. It is the purpose of mitigating those risks that drive their inclusion in a plan.

    A couple more thoughts. Just because an item has a high cost, does not necessarily mean it isn’t useful. It’s just a question of how much you personally value the service provided, or how much you would be willing to pay to shift risk to some other entity that determines if the cost is reasonable.

    And CC, his first name is Moshe, not Mose, so you may want to fix the first line in the post.

  8. You are starting to ask the right quesetions. One more might be whether annuities are also too expensive for many higher-net worth individuals, who have a lower probability of out-living their investments.

  9. @Michael James: The book does not endorse any GMWB products. It lists all the ones available today and briefly mentions the fees. But I would have liked to see a discussion on whether the high fees outweigh the benefits of these products.

    @AKA: Actually, regular annuities provide a lifelong income. In fact, retirees can also purchase inflation-adjusted annuities. The cost in GMWBs is not due to the insurance part. I understand perfectly that if you want insurance there is a cost to it. It’s the high cost of the mutual funds held in a GMWB that makes them prohibitively expensive.

    I wonder if investors can do better on their own. A $100K GMWB will provide with a $5,000 base income for life. An annuity purchased for the same amount provides an annual benefit of $7,440 based on rates available here.

    http://www.canadianbusiness.com/my_money/rates/annuity_single_life_male_no_guarantee/index.jsp

    Retirees could purchase an annuity for $67,000 that will provide a guaranteed income of $5,000. They could purchase a low-cost equity fund with the rest of their capital, which will provide another $825 in dividend income (2.5% dividend yield on $33,000). The downside to this alternative is that a retiree who passes away in the early years of the plan would likely leave a smaller estate than in a GMWB.

    ‘Mose’ is a typo. I’ll fix it.

    @Dale: These questions were raised before. It’s simply being asked again:

    http://www.canadiancapitalist.com/manulife-incomeplus-versus-a-bond-portfolio/
    http://www.canadiancapitalist.com/manulife-incomeplus-dont-ignore-dividends/
    http://www.canadiancapitalist.com/manulife-income-plus-the-high-cost-of-peace-of-mind/

    The book calls it a Wealth-to-Needs (WtN) ratio. If you have a very high WtN, you are likely not worried about ever running out of money. But it’s a tiny fraction of the population who are in that happy situation. The rest have to worry about how to make their nest eggs last as long as they live.

  10. @Money Smarts Blog. From what I understand about a RRIF, you hand over the keys to your RRSP and they convert it into a product that draws down a certain amount of cash from it annually until, say, after whatever term, you have 0 dollars remaining. Like a reverse mortgage.

    The only reason why I’m concerned about RRIFs is with the management of said RRIFs – I haven’t looked into it, but I’m sure the buggers are skimming plenty of cash off your savings just to “administer” the RRIF. If I spend a lifetime self-managing my RRSP, why would I want some leach draining cash off out my RRIF?

  11. @Traciatim. That term has been so overused that I don’t think anybody knows what an “average Canadian” is anymore. My comments in here apply to what I would consider to be financially educated people – after all, this is part of MoneySense magazine now.

    I’m guessing that people who never budget, never save and always blow away cash windfalls on downpayments for fancy cars, boats or electronics and live for the day without considering the consequences of tomorrow – simply aren’t the demographic who would be reading this blog…

  12. @CC – While the book does not endorse any GMWB product, Manulife certaily endorses the book – http://www.retirementsolutionscentre.ca/en/product-allocation/intro.html

    In any event, I think the suggestion of the GMWB product as a silo is intended for people that want to leave a legacy and yet still want a stable income.

  13. Phil, the problem is financially educated people can make any amount of money. Average income in Canada is around 75K per family. The Daily just put out it’s average incomes on September 16th by census metropolitan area. If you take the average of all the cities they list you come up with 73137, with a standard deviation of 7716. So saying that the average Canadian Family makes between 65K and 81K is going to be reasonably accurate.

    Do you really think people are putting 18% of their incomes in their RRSP and also 6% – 7.5% in to a TSFA? Sure, there are some people like AKA who max out the one that makes sense, but they are very few and far between. Generally (just look at RRSP average contributions and contribution room stats) people do not max their RRSP and I very much doubt usage levels of TFSA contribution room are even anywhere near 25%. I haven’t been able to find stats on it though.

  14. The GMWBs are one of the big reasons why Manulife’s stock has cratered. They sold a ton of them and didn’t hedge much of the exposure to stock market fluctuations. Manulife is in the process of rectifying their misstep and presumably the company will be OK (although there may be some lingering uncertainties for some on this point). Regulators have also indicated they will be introducing new reserve requirements for GMWBs, which could possibly end up raising the cost base for this product In short, it seems to me there is a fair amount of uncertainty surrounding GMWBs in their present form

  15. @Traciatim. I have no idea what the so-called “average Canadian” is doing. But I would venture to guess that the demographic who are interested enough in personal finance to read this blog probably puts down a significant contribution into their RRSP or TFSA or both every year.

    What say you readers out there? Let’s have a poll… ;0)

  16. I’ve always maxed out my RRSPs & now the TFSA every year. I believe the vast majority of readers of PF blogs are themselves very diligent with their finances. Especially here where most posts are on investing.

  17. Phil, I put 6% of my salary in an RRSP (company matched, so really 12%). Otherwise I’m in debt up to my eyeballs. My family is in the average Canadian family range I noted above. My spouse saves essentially nothing. The debt is two spouses with student loans, a single car loan, and a mortgage . . . not credit card debt or random personal loan.

    CC, but what about your family income, is it less, within, or higher than the range I posted as the “Average Canadian” income?

    • @Traciatim: Right now, our household income is higher than the Canadian average and median. That’s why even with 3 kids it’s possible for me to max out the RRSPs and TFSAs. But it wasn’t always like this. For some years, we were within the Canadian averages and even then we maxed out. Of course, we didn’t have kids then, so it was easier.

      We all have different circumstances and who knows if we can continue to max out in the future. IMO, the most important thing is that we save *something* as our circumstances allow.

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  21. Careful with this investment…read the fine print …i.e. 1st dollar in 1st dollar out…..resets will cost you a % of gross and if you change your mind about this investment i will cost you …but your adviser will still make big dollars on this…SF and DSC…on this baby

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  23. Writing as one of the authors of the book, I am going to say I think it is an overstatement to say that the book suggests that retirees “should” allocate some of their “nest eggs” to GLWBs.

    In Pensionize Your Nest Egg, we describe the new financial risks that retirees face, and how different product silos protect or hedge against those risks.

    But we do not recommend any particular product allocation and, in fact, ALL of the case studies we use model retirement portfolios with plain vanilla single premium immediate annuities, not GLWBs.

    Other commenters have pointed this out – but the reason investors may choose to use GLWBs as opposed to (or in addition to) SPIAs is the retained liquidity with GLWBS. And, again, for what it’s worth, my co-author has argued for some time for the use of lower-cost alternatives in the GLWB silo – including ETFs and index funds. See in particular http://www.advisorone.com/article/frustrations-variable-annuity-advocate

  24. I purchased a GMWB product in 2008 (sunwise elite plus). Since the purchase I have read many negative comments. Not keeping up with inflation and many more. Bottom line is I think a person could do better without them. So in hindsight I wish my advisor had never mentioned them. My question is, should I, can I, get out of them. I realize there will be DSC charges which I could accept by letting the DSC lapse over a few more years by keeping the mutual funds intact. Is there any way I could get out of the GMWB and what it would cost to do so. As I mentioned before a lot has been written about how this product is not for everyone, but not to much on what to do to get out of them.

  25. @Alexandra: Thank you for the clarification. I agree that “should” is my wording but that’s the impression I got from the book. Here’s an excerpt from Page 66: “As we’ve said, it intuitively makes sense to spread your nest egg across these three product silos — “. I also agree that GLWBs will me much more attractive if offered with passive investment products.

    @Bgilbert: Why are you disappointed with Sunwise Elite Plus? It would seem to me that someone who purchased a GLWB product in 2008 would be happy to have avoided the financial mess late in that year.

  26. @CC – you shouldn’t plan your retirement using intuition! On page 100: “Our intention is to get you thinking about how (and if) [GLWBs] can work for you.” ;)

  27. CC,if Bgilbert Purchased GLWB sometime between Jan.- July 208 he’s well under water ,the sad part of this is Advisers were selling this based on investor fear….GIF’s are advisers cash cow, every time they reset,they get SF plus a bonus on the DSC…..plus the insurance seg funds are pulling big fees….the best advise i can give BG,is have some one run the numbers for a good work out plan.

  28. @Bgilbert: You need to ask yourself why you bought a GMWB in the first place. If your objectives haven’t changed, then why would you want to exit? So what if it doesn’t keep up with inflation. If you planned it well, you are also investing in other vehicles that will address that issue. If Manulife or anyone other insurance carrier added an inflation protection, can you imagine the additional fees that would be necessary to offer such guarantees???

    Ultimately, the GMWB helps investors achieve a sustainable *lifetime* income, regardless of market performance.

  29. Thank you everyone for this helpful discussion.
    I am trying to get a sense of possibilities and risk for something like INcome Plus.

    As I near 55 I have the option of moving what is in a defined benefit pension of 19 years (from former employment) into something that may grow more, such as Income Plus. My current pension is indexed 80% of cost of living up to a max of 3%. So there is some protection for inflation. The value of this pension is $400,000, (If i take it out 276,000 would have to go into some other plan, the remainder 124, 000 would come to me with the tax hit, so let’s say I would get $80,000). I have my current pension with my employer that is contribution defined-through sunlife (working last 6 years likely to go for another 10 years, when I retire at 65).
    I still own on a mortgage and would like to pay that down (around $135,000). Have 1 loan (33,000) would like to also kill that.

    I am loathe to take out the indexed pension but it will always only be what it is..plus cost of living. Getting out of debt is “big” in my mind and perhaps worth the risk of moving to something like Income Plus. My principal may draw down but I still would have some predictable income (not indexed though) and this may be not so bad if I have no debt.

    I know this information is incomplete but but I would be very interested in reading people’s comments on this if you would offer them.
    best
    tm

  30. I invested into this product 2 years ago at age 43. If ‘resets’ go my way (timing) the investment will at least double in 22 years. Granted, I could chance it and invest in equities etc. myself for the next twenty years but… I’ll take the ‘guarantee’ anyday.

    Other features not discussed are: it is sheltered from creditors during bankruptcy. At my age, divorces still run around 30%. Tough economy, demanding ex-wife, single income? Bankruptcy almost seems to be the norm following divorce.

    It is not subject to probate following death. Another nice feature.

    Service. I feel alot more ‘in the loop’ from my advisor than my banker.

    I just feel this product ought to be the base of your financial ‘pyramid’, followed by my company/union pension, then the TFSA at the top. Time will tell!

  31. @argus,

    Thanks for the information.

    I am still working the numbers…interestingly I could leave my defined pension benefit pension in and receive the same payout, even while taking out the excess value of the fund.

    That’s something I am thinking about. as well.
    best
    tm

  32. Well it’s a year later almost.
    I did buy in to the manulife plus system.
    Hoping it works ok…..

    Given that the markets are now tanking again with the latest USA debt problem…getting a guaranteed return of 5% seems to have not been such a bad thing.

    Guess I will see in the long run. I do hope the markets pick up because my payout will then reset, but if not…at least I have this in hand (along with some other capital).
    regards

  33. CC,

    I thought I’d update you on the “income for life funds”

    In a nutshell many insurance companies have drop these funds or guarantees etc. Why? Poor markets for sure.

    So getting 5% or 7% a year maybe was not a bad thing after all.

    Brian

  34. @Brian: Just because these GMWB products sold in the past have become burnt the insurance companies does not automatically mean these products were winners for clients. The insurance companies are cutting back on guarantees because they did not hedge their exposure properly in the past and regulators are tightening up the rules.

    As the book Pensionize Your Nest Egg argues there is a place for this product for those in or nearing retirement. The steep costs involved makes one question whether they override the advantages.

  35. CC,

    I think you maybe using Manulife as your example. Costs (fees) are high no questions about it. One should not put all their eggs in one basket. If the markets get well again at some point the insurance companies will come back, since that maybe awhile off the GMWB may be good as you pointed out at or near retirement. We should revisit this in another year.

  36. The fees you are quoting are pretty high, you must be looking at high equity based options. I don’t find other provider fees high. Yes there is the guarantee fee ontop of the MER but a small price to pay for lifetime income. Over the long run the mid-growth options perform just as well with lower fees. The next question is how long do your retirement funds need to last…..forever…..how long is that? Nobody knows. What would someone be willing to pay ,if they were now 85 and have outlived their savings, to have lifetime income after they have extinguished their savings? What growth rate can you reasonably project for someone during retirement? Not very high. I can project 5%…GUARANTEED. If you are using more than 2% outside of a GMWB for a retiree then you are projecting a rate with more risk exposure than you should. Also, GMWB is an amazing vehicle for RRIFing. A GMWB is one of the most effective tools to mitigate real and serious capital risks for retirees.

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