Deferred Variable Annuity – Rollup Rates: Part 2

Mutual Funds

This article is part of a series; click here to read Part 1

How long does the guaranteed rollup rate last? Does it have any other features?

Guaranteed rollup rates for the benefit base generally end once guaranteed distributions from the contract have commenced. As well, in cases where those distributions do not begin for a long period of time, the rollup rate may only last for a certain number of years.

Some variable annuities may have other guaranteed growth features as well. For instance, one might see a bonus applied to their initial premium, such that the initial benefit base is higher than the premium. Another possibility could be that the benefit base is guaranteed to double after a certain number of years if underlying contract value growth did not otherwise jump far enough ahead of the guaranteed rollup rate to have independently caused this.

How frequent are the step-ups to the benefit base? When are they applied?

Another reason that the benefit base can increase is because the contract value of the underlying assets has grown to achieve a new high watermark that exceeds the value of the guaranteed benefit base provided through rollups. We must consider how frequently these new high watermark step-up possibilities are checked for the benefit base and when they vest. Most commonly, these step-ups are applied for contract value growth on an annual basis at the contract anniversary date. If the contract is worth more than the guaranteed benefit base on the contract anniversary date, then the benefit base is adjusted upward to match the contract value at this time. In these cases, if the contract value reached a new high watermark earlier in the year but then dropped by the anniversary date, the higher earlier value would not matter. Only the value on the designated dates is used to determine if a new high watermark has been achieved.

Naturally, the ability to apply step-ups on a more frequent basis, such as daily, monthly, or quarterly, is valuable to the annuity holder. It creates more opportunities for growth in the contract value to achieve new high watermarks for the benefit base. When these step-up opportunities are applied more frequently than on an annual basis, it is important to also know about when they vest. If they do not vest until the anniversary date, then this can again create issues for those seeking to begin distributions midyear if a new high watermark for the benefit base has not yet vested to increase the guaranteed income.

How does the rollup rate interact with step-ups?

A final consideration for deferrals is how the rollup rate reacts to step-ups for the benefit base. What happens when the contract value achieves a new high watermark above the guaranteed rollup rate? There are two basic options. The rollup rate might only be applied to the original premium, or it may stack on top of new high watermarks achieved through asset growth. The latter case is more advantageous to the annuity owner. The easiest way to understand this is with an example.

Exhibit 5.2 provides such an example for a $100,000 premium placed into a variable annuity with a ten-year deferral period that offers a 5 percent annual compounded rollup rate that is vested on each contract anniversary as in Exhibit 5.1. The contract value for the underlying annuity assets is also shown in the exhibit. The growth of the contract value was chosen for this example to more clearly illustrate the difference for stacking the rollup rate on step-ups. The contract value trails the guaranteed rollup rate until age fifty-nine when a very large market return pushes the contract value well above the benefit base. This market growth creates a step-up to the new high watermark for the benefit base. Then the contract value subsequently declines and trails the benefit base for the remainder of the deferral period. With that step-up at age fifty-nine, there are two ways that the rollups may respond. Without stacking, the rollup continues to apply only to the original premium and the benefit base stays at the high watermark level achieved at age fifty-nine until age sixty-three when the cumulative rollups once again allow the benefit base to grow. In this example, the benefit base at age sixty-five ends up at the same $162,890 value. There was a temporary period between ages fifty-nine and sixty-three where the benefit base was larger, which could have been beneficial if the owner decided to begin lifetime distributions earlier than planned, but it otherwise does not impact the amount of guaranteed income if distributions begin at sixty-five.

We can observe how stacking leads to a much better outcome in this example. With stacking, once the new high watermark was achieved at age fifty-nine, the rollup rate begins to be applied to this new high watermark, rather than only being applied to the original premium. This allows for greater subsequent growth of the benefit base at the rollup rate from that new high watermark. In this example, stacking allowed the benefit base to grow to $194,477 at age sixty-five. This stacking has laid a foundation for 19 percent more guaranteed lifetime income from the annuity.

Exhibit 5.2 Guaranteed Benefit Base for $100,000 Premium in a Variable Annuity with a 5 Percent Annually Compounded Rollup Rate Comparing the Benefit Base with Rollups Stacking on Step-Ups

This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon


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