The role of GMWBS in estate planning

I frequently come across clients who own Guaranteed Minimum Withdrawal Benefit (GMWB) plans or are considering purchasing one, and many don’t fully understand the plans because, let’s face it, they’re complicated.

Trying to compare the different income options, fees, investments and guarantees offered by each company can be like navigating a vine- and baboon-infested jungle. Clients are rarely equipped with the necessary survival pack to make it through to the other side of that tropical “paradise” with the exact product they want and need in hand – which is why they come to you.

GMWB or Lifetime Income Benefit (LIB) plans are the newest insurance-based income product to hit the Canadian market, and we’ve already seen rapid changes occur in the products offered by the major players. It’s important to remember that, while a GMWB/LIB plan is still a segregated fund (it is!), there are some vital differences in the guarantees. The focus of a regular segregated fund tends to be on principal protection. Many clients purchase segregated funds intending to hold them until the end of the maturity period, or even death, ensuring there’s something to pass on to their beneficiaries in the most tax-efficient and private manner possible.

The major focus of a GMWB/LIB plan is not principal protection, and that’s why it’s important to determine if these are right for your clients. The primary focus of a GMWB/LIB plan is, of course, income. These plans do a great job of addressing the need for income. But what happens to the capital when it comes to estate planning?

So what is the estate benefit?

It’s important to understand the fine print when you’re talking to clients about what will pass to their estate or beneficiaries and the cost of higher death benefit guarantees. There are three key advantages and one key issue to be aware of when selecting GMWB/LIB plans.

THE ADVANTAGES

1. Beneficiary Designations

The primary benefits for estate planning are the same for GMWB/LIB plans as they are for segregated funds, one of which is the ability to name a beneficiary if the plan is held off-book. The advantages of named beneficiaries are:

The potential for creditor protection;
The privacy gained when assets pass directly to beneficiaries rather than through the estate; and
The ability to bypass probate. Probate is a non-issue for clients in Alberta, where it is a flat fee of $400. In most provinces, probate ranges from 0.4% to 0.7%, which is a small percentage. However, in provinces such as British Columbia and Ontario, probate is 1.4% and 1.5%, respectively (above varying minimums) – and becomes a significant issue.

Named beneficiary designations can also decrease the time and expense of settling an estate. This, in turn, means fewer headaches and hassle for an estate’s executor.

Most people look after assigning someone as the Primary Beneficiary – usually their spouse. However, not many people add children and grandchildren (if they are age of majority) as contingent or secondary beneficiaries. What a great way to add value to a client meeting! It’s great for clients because naming secondary beneficiaries doesn’t cost anything to implement, they can change their minds so their kids still have to be nice to them, and finally, they still own and control the asset that they might need in later years (beating out the joint ownership option).

2. Protection for Spouse

In addition to saving probate at death, two companies, Manulife and Desjardins, offer a joint life option, a new enhancement for these products that offers clients a little more estate planning flexibility. As with any guaranteed income product, a GMWB/LIB plan with this enhancement can provide the added benefit of continuing the income to the surviving spouse when one spouse passes on. This added feature makes these products more closely resemble a pension plan. So GMWB/LIB plans, as well as annuities, are attractive options for clients without a pension plan.

3. Investment for later ages

Most companies limit the age at which one can purchase a GMWB/LIB plan. It’s here, as well as in the guarantees, that you can feel the insurance side of these products kicking in. Most companies have a maximum purchase age of 80, with some exceptions. The following companies have different maximum purchase ages:

Manulife: To age 75
Desjardins Helios: To age 95

THAT ONE PESKY DISADVANTAGE

1. The Effects of Withdrawals on the Death Benefit

The standard definition in the marketing materials says: “100% of your deposits less proportionate withdrawals.” The “deposit” amount that the death benefit is based upon will be adjusted upwards to reflect market value resets. Most companies reset the death benefit guarantee every three years, on the policy anniversary. CI SunWise has a 4% Automatic Death Benefit Reset Rider (for Class B only on deposits prior to age 80) that increases the deposit by 4% simple interest. The cost of this rider is 0.25% per year, charged quarterly, and must be opted for at the time the contract is established, as it cannot be added later. Desjardins Helios has a nice feature for 75/100i contracts that allows the death benefit to be adjusted for inflation by the Consumer Price Index, or the market value, whichever is higher at death, and there is no additional MER for this feature – it’s free! These two plans allow clients to offset the effect of proportionate withdrawals on the death guarantee, but still does not eliminate it. Most other carriers have automatic resets on a specified day, usually the anniversary date of the initial purchase. This significantly reduces the likelihood of achieving a reset.

The important wording to remember when it comes to the withdrawals is “proportionate.” The death benefit guarantee is not “100% of your deposits less withdrawals,” it is “100% of your deposits less proportionate withdrawals.” So the death benefit guarantee is based on the following calculation:

Death benefit guarantee X (Withdrawal/Market Value) = Amount of reduction in death benefit

Why does this make a difference? In situations where the market value has dropped and a withdrawal is taken, the withdrawal will represent a larger proportion than the actual dollar amount withdrawn. This will dramatically reduce the remaining death benefit. The opposite is true if the market value is up and a withdrawal is taken as there will be less of an impact on the death benefit guarantee. Let’s review the following example:

Actual Withdrawals

What you might expect with an Actual Withdrawal Reduction in Death Benefit (not what actually happens):

Initial Deposit	Market Value (with gains)	Death Benefit Guarantee	Withdrawal	Market Value before Withdrawal	Market Value after Withdrawal	Death Benefit Guarantee
$50,000	$60,000	$50,000	$2,000	$60,000	$58,000	$58,000 (60,000 – 2,000)

Up Market Scenario with Proportionate Withdrawal Reduction in Death Benefit (what actually happens):

Initial Deposit	Market Value (with gains)	Death Benefit Guarantee (assuming no resets)	Withdrawal	Market Value before Withdrawal	Market Value after Withdrawal	Death Benefit Guarantee
$50,000	$60,000	$50,000	$2,000	$60,000	$58,000	$48,333.33 (50,000 – [$50,000 X ($2,000/$60,000) = $1,666.67])

Down Market Scenario with Proportionate Withdrawal Reduction in Death Benefit (what actually happens):

Initial Deposit	Market Value (with losses)	Death Benefit Guarantee	Withdrawal	Market Value before Withdrawal	Market Value after Withdrawal	Death Benefit Guarantee
$50,000	$40,000	$50,000	$2,000	$40,000	$38,000	$42,500 (50,000 – [$50,000 X ($2,000/$40,000) = $2,500])

As you can see by the above examples, withdrawals in a down market will decrease the death benefit to a greater degree than in an up market. The proportional decrease concept works to the benefit of the client when the market is up, but not when the market is down. This is an important concept to keep in mind. Some companies have additional death benefit guarantees that you can build in for an extra cost to soften the blow, but none of them change the effect of proportionate withdrawals.

Estate Planning or Retirement Planning?

The primary goal of GMWB/LIB plans is to address the risk of outliving savings through retirement, reduction of purchasing power due to inflation and the depletion of savings due to market corrections. Your client can experience some of the peace of mind that comes with guaranteed income, while at the same time having exposure to the market and possibly leaving something behind for their heirs.

If estate planning is your client’s primary goal, however, you might consider an insured annuity first, a segregated mutual fund second and a life annuity with extended guarantee period last.

Alternately, if guaranteed retirement income is your client’s primary goal, but exposure to the markets is important as well, a Guaranteed Minimum Withdrawal Benefit or Lifetime Income Benefit plan could be just what the doctor ordered.

Cindy D. David, CFP, CLU is Vice President, Estate Planning Advisor, with Raymond James Financial Planning.