You might have definitely come across the term Guaranteed Minimum Income Benefit (GMIB) rider while purchasing an annuity. It’s one of the popular add-ons (rider) available in the annuity contract, which can provide you with a minimum level of income, regardless of the market performance.
Different annuity providers/insurance companies call it by different terms, such as Guaranteed Retirement Income Program (GRIP), Guaranteed Interest Account (GIA), RIG, MAP, and Income Guard. But what exactly is a GMIB rider? How does it work? And is it the right option for your retirement plan? This article will explore everything you need to know about GMIB riders.
What is a GMIB Rider?
You can think of GMIB riders as insurance policies that provide a minimum income guarantee to the policyholder. An insurance company invests premiums paid by policyholders and assures minimum income despite market fluctuations. Income level depends on a percentage of initial investment and is adjusted for inflation over time.
Usually, variable annuities provide investors with a range of investment options to choose from when purchasing them. The annuity payments are determined, in part, by the performance of the underlying investments when annuitized, typically exercisable after the 10th year, and require that you annuitize the entire contract (some contracts permit you to utilize your GMIB provision earlier, while others enable partial annuitizations). The appeal of variable annuities lies in their potential to benefit from market growth. However, the value of the annuity may decrease in the event of market declines, resulting in lower payouts.
The GMIB provides a guaranteed minimum income benefit to annuitants, regardless of market conditions. The predetermined minimum payment amount is based on an assessment of the initial investment’s future value. This option is advantageous to annuitants who intend to annuitize their annuity and keep up with inflation.
How does the GMIB Rider Work?
Let’s try and understand the rider with the help of a hypothetical example.
Assume that you bought a variable annuity with a GMIB rider for $100,000 with a compounding rate of 6%. You agreed to receive life-long payouts from the insurance company after 10 years, regardless of the annuity contract’s value. During the 10-year accumulation phase, the market only returned a 5% annual profit on your initial premium of $100,000, resulting in a variable annuity worth $162,889.
Your payout is determined based on the higher of the GMIB account value or the annuity’s market value, as guaranteed minimum income benefits always work this way. Since you have a GMIB rider, your payout is based on the GMIB account value of $179,084, which is compounded at 6 percent, exceeding the base annuity’s 5% annual return.
High-Water Mark – An Additional Feature
Some GMIB riders guarantee annuity payout based on the highest value your investment ever achieved, known as the high-water mark. So, if your income base reduces drastically after reaching a certain high, you will still get GMIB benefits as per your highest-ever achieved income base.
How Is It Different From GMWB?
A GMIB rider guarantees a minimum level of income from your annuity, regardless of market performance. The income can be deferred for a future period or simply added to your benefit base. In contrast, a Guaranteed Minimum Withdrawal Benefit (GMWB) Rider is another type of insurance policy rider that guarantees a minimum level of withdrawal amounts to the policyholder, regardless of market conditions or fluctuations in the value of the underlying investments.
Discussing the Key Merit
A key advantage of GMIB riders is that they provide a safety net for retirees and other individuals at risk of outliving their savings. Financial markets’ volatility makes the risk of running out of money in old age a genuine concern for traditional retirement accounts. GMIB riders provide a level of certainty and stability, helping individuals to plan for the future with greater confidence.
Not Free From Drawbacks
An additional issue pertains to the expense of GMIB riders. Because they guarantee a minimum income level regardless of market performance, insurance companies must set aside a significant amount of capital to cover potential losses. This can make GMIB riders more expensive than traditional retirement accounts, which may make them less accessible to those who need them the most since the withdrawal of the investment account is not permitted.
The tax implications of a GMIB rider depend on several factors, including the annuitization method and the investor’s tax bracket. Investing in a variable annuity with a GMIB rider allows deferral of taxes on investment gains and income until payouts begin. Payments received are subject to ordinary income tax and taxed at the prevailing rate corresponding to your income tax bracket.
When you annuitize your variable annuity with GMIB, the exclusion ratio calculates the taxable part of each payment. To calculate the exclusion ratio, you divide the investment’s cost basis by the expected payout amount over your lifetime. The cost basis is the total amount you have invested in the annuity, including any additional contributions.
Suppose you invest $100,000 in a variable annuity with GMIB rider, and the annuity’s value grew to $150,000 over time. You decide to begin receiving annuity payouts and the insurance company guarantees a lifetime payout of $1,000 per month.
Assuming a life expectancy of 20 years, the expected payout over your lifetime would be $240,000 ($1,000 per month x 12 months x 20 years). To calculate the exclusion ratio, you divide the cost basis ($100,000) by the expected payout amount ($240,000), which gives you an exclusion ratio of 0.42 (or 42%).
It means that 42% of each payment you receive ($420) is your investment and is not subject to tax. The remaining 58% ($580) is taxable income subject to income tax based on your tax bracket at that time.
In a Nutshell…
Despite adding costs and complexities to the annuities, GMIB riders may prove to be a promising option for policymakers and individuals seeking to address income insecurity. GMIB riders promote financial stability and well-being by offering a safety net and minimizing the risk of outliving one’s savings. Although GMIBs can come with high costs, the benefits may exceed the costs for some individuals. You should consult your trusted financial advisor if you do not thoroughly understand this rider.
GMIB payout is taxed based on the exclusion ratio, which takes into account the investment’s cost basis and the expected payout amount over your lifetime. A portion of each payment is considered a non-taxable investment return, while the rest is taxed as ordinary income. It is best to consult a tax professional to understand the specific tax implications for your situation.