Last week I received the following question on GMWBs (Guaranteed Minimum Withdrawal Benefit insurance products) that I discussed in earlier blogs.

Question:  “GMWB discussions. Time to update your conclusions. Outdated pre-2008 markets. Inflation numbers of 3%, GIC numbers of 5%?  Will be interested to see part III of this.”

Answer: It’s a good question, since the world changed somewhat in the fall of 2008; given that my original GMWB I – Guaranteed Minimum Withdrawal Benefit (Preliminary) and GMWB II- Guaranteed Minimum Withdrawal Benefit II blogs were written “pre-2008” crisis”, are the conclusions still valid? I haven’t done, and I have no plans to do, another GMWB study because the conclusions would be essemtially unchanged.

What did change is that consensus for market return expectations are lower than “pre-2008” for both fixed income and equity investments, though obviously we don’t know what will actually happen in the future. However what we do know is that all-in GMWB costs (Vanguard’s new product aside) are still in the 2.5-3.5% range. Given, say, 5% annual minimum withdrawals coupled with the 2.5-3.5% annual costs, the returns from typically permitted stock bond mixes in (variable annuity) GMWB/GLWB plans are almost certain to result in decreased residual value of the portfolio; i.e. what you are getting over time is return of capital and the opportunity for the upside is a triumph of hope over reality. Remember what is guaranteed is not that you are getting a minimum of 5% return on your remaining assets, but the you are  getting an annual payment of (typically) 5% of the high-water mark of the annual valuation of residual assets.

With the exception of the recent availability of Vanguard’s new product which I reviewed in Vanguard GLWB, the mid-2008 conclusions in GMWB-II would be essentially unchanged in a new detailed analysis under the 2012 circumstances: “The Guaranteed Minimum Withdrawal Benefit (GMWB) products with a 3.5% management fee have nothing to offer to even conservative investors, even when they are compared to annuities… At 1.5% management fee, GMWBs may become interesting to individuals who would otherwise invest in an annuity or GIC/CDs. But over a 40 year retirement, use of GMWB/ Annuities/ GIC/CD exclusively would lead to a relentless erosion of the investor’s purchasing power.” Vanguard’s GLWB has all-in cost of under 1.5%; unfortunately it’s unavailable in Canada.