What is a Guaranteed Minimum Withdrawal Benefit (GMWB)?

A guaranteed minimum withdrawal benefit contract is an insurance investment product that can offer a guaranteed income amount for a period of time or for the life of the individual on which the contract is based. Guaranteed minimum withdrawal benefits provide three types of guarantees; income, maturity, and death benefit.

What is a Guaranteed Minimum Withdrawal Benefit (GMWB) Video Summary

How Do Guaranteed Minimum Withdrawal Benefits Work?

When an investor purchases a guaranteed minimum withdrawal benefits contract (GMWB), they are guaranteed to receive a certain amount of annual income that may range from 3% to 5% based on the initial principal amount the investor deposited. For example, if an investor purchased a guaranteed minimum withdrawal benefit with a $100,000 deposit that offered a guaranteed annual withdrawal of 3% ($3,000) for the investor’s life. As such, the investor would continue to receive the $3000 payment annually regardless of the performance of the investments, which provides the investor income protection against poor market performance.

How GMWB Can Increase Retirement Income

The product’s reset feature is one of the biggest benefits of purchasing a guaranteed minimum withdrawal benefit. The reset future allows the initial balance to be reset to the current market value, which means the annual income amount provided can increase as the underlining investment value also increase.

For example, if we continue with our example above of the $100,000 GMWB purchased with a 3% guaranteed withdrawal income payment. Let’s assume that the investment did well, and in year two, the starting balance is now $150,000. As such, with the reset feature of the GMWB, the new principal amount that the 3% minimum withdrawal amount would be based on will be $150,000. Therefore, the annual income received now will be $4,500, a $1,500 increase.

The annual withdrawal rate of 3% remains the same but the amount paid increases as it’s based on the $150,000 balance and not the initial $100,000 deposit. Furthermore, if the investment decreased to $140,000 a year later, the annual income paid would not be reduced but would remain at $4,500. The reset feature only comes into play when the investments have increased; typically, GMWB contracts offer a reset every three years.

Investors who purchase GMWB also retain control of their investments, allowing them to cash out at any time. However, they would also forfeit all guarantees offered by the GMWB contract.

What are the benefits of Guaranteed Minimum Withdrawal Benefit Contracts?

As outlined above, one of the main benefits of this product is the reset feature, which enables owners of this product to participate in the market without downside risk but still capture any gains above their initial investment.

The death benefit offered by GMWB is another great benefit. If the owner of a guaranteed minimum income benefit contract dies, they are usually guaranteed 75% of their initial deposit is paid to their designated beneficiary.

Since GMWB is an insurance product with similar features as a segregated fund, GMWB allows for the naming of a beneficiary, which means proceeds can avoid being included in probate. GMWB also offers creditor protection, and if the insurance company goes bankrupt, these products are covered by Canada’s insurer of insurance company, Assuris.

Suppose bankruptcy occurs to a company offering a GMWB. In that case, Assuris will provide you with a payment of $60,000 or 85% of the guaranteed withdrawal benefit balance, assuming no withdrawals have commenced. If withdrawals have commenced, you can expect to receive $2,000 per month or 85% of the guaranteed income benefit you were receiving.

Disadvantages of a Guaranteed Minimum Withdrawal Benefit?

All the advantages provided by GMWB do come at a cost. That’s perhaps the biggest disadvantage of this product. Fees on this product can be extremely high, and these fees can eat into your initial principle or reduce your overall investment return. Looking at this product’s fee structure before purchasing it is critical.

For example, while the product has a reset feature, the fee charged might mean you need to earn a higher return to ensure your investment continues to grow. If a GMWB has an annual investment management fee of 4%, you will need to earn 5% at minimum to have a positive investment gain after deducting fees.

Is it worth it to Purchase a Guaranteed Minimum Withdrawal Benefit Contract?

This product can be a great product depending on your specific situation. The primary risk this product aims to resolve is longevity and market risk, which this product addresses. The fact that the underlining investments are controlled by the investor is another positive for this product.

If perhaps you have no retirement benefits and you’re looking for a product that will pay you a minimum amount of income annually based on your principle available but still enable you to participate in the market at no risk, then looking into the guaranteed minimum withdrawal benefit might be worthwhile.

On the flip side, this might not be a great product if you already have a defined benefit plan that pays you a reasonable retirement income.

While the product has some great benefits, the fees charged can make this product less enticing. It’s possible for someone to lose all their gains to fees, which wouldn’t offer them much benefit on the reset after fees are accounted for.

The bottom line on this one is buyers beware and ensure you do your due diligence on this product before purchasing.