The bad news is that the average VA buyer can't begin to unravel the mind-boggling complexities involved in living benefits. In the oldest such benefit, a Guaranteed Minimum Income Benefit (GMIB), myriad complex choices are available.

For some VA owners, there may be only one person within miles who has the knowledge, experience and analytical skills to explain the options and optimize living benefits. That person is you.

For your clients who own VAs with living benefits and for every such prospect, this can be a unique, high-value service that will distinguish you from competitors, strengthen relationships and generate referrals. This is intuitive to me and perhaps to you.

But it does not seem intuitive to a U.S. life insurance industry that has been pumping out living benefits in massive quantities for years. The industry has a moral obligation to help every VA-owning client who holds a GMIB – by providing education, guidance and analysis of options. So far, I have not heard of any company that is proactively encouraging and training its agents to provide this service.

That's why I have written this column to help you optimize GMIBs. I would like to warn you in advance that this topic is the financial version of Rubik's Cube, with many moving parts and complexities, all compounded by the current environment and its uncertainties. That should make the challenge or providing this service even more motivating for you.

GMIBs: The Worst Way to Annuitize

Of the two major types of VA living benefits, GMIBs are the most complex to evaluate. As I explained in a previous column, the other type – Guaranteed Minimum Withdrawal Benefits (GMWBs) – can only pay off if VA owners choose to make a series of withdrawals over 15-20 years, retain the contract that long, and live that long.

• Why You Should Help Clients Evaluate GMWBs

Even then, most GMWBs will only return the original deposits in inflation-eroded dollars. The best course of action for many underwater VA owners with GMWBs is to start taking withdrawals as soon as possible and keep at it.

GMIB's however, are a different can of worms. Invented by AXA Equitable and introduced in the U.S. market 14 years ago, GMIBs were the first of several types of living benefits that have driven the modern VA sales boom. The sales pitch for GMIBs is relatively simple and powerful: "If the stock market crashes and the account value of your VA declines, you can choose to annuitize (after 7-10 years), and your annuity payments will be based on a guaranteed Benefit Base that is separate from your account value. Not only is this Benefit Base guaranteed not to decline – it is guaranteed by the insurance company to increase by 4-6% annually."

Example: A client put $100,000 into a VA with GMIB in 2001. The account value currently is $80,000 but the GMIB Benefit Base has increased to $140,000. The client now has the option to annuitize $140,000. And why wouldn't this choice be preferable to waiting years in the hope that account value will return "above water?"

This is where complexities begin. There are three ways to obtain a guaranteed annuitized income stream from a life insurance company. The best way is to shop around and compare quotes on immediate annuities. The payout choices are great and rates are current and competitive, because otherwise insurance companies can't win business.

A second way is to annuitize a tax-deferred annuity. In this case, rates are set by contract, but they generally are "straight" – meaning they reflect the annuitants' actual age and mortality. A variety of payout periods always are offered.

The worst way to annuitize is to exercise a GMIB – for three reasons:

1. Payments are determined using an "age-reduction factor" that effectively treats the annuitant as a person 5-10 years younger for mortality purposes, thus paying out less. In some contracts, the age reduction factors decline with age or VA holding periods.
2. Some insurance companies contractually set interest rates used for GMIB payouts lower than comparable rates used for other types of annuitization.
3. All companies greatly restrict GMIB annuity payouts periods. For example, some companies limit the choices to life, life with 10-year certain, or joint & survivor with 10-year certain.

In many GMIBs, all three provision work together to reduce the company's risk. But the industry's gain is the consumer's loss when it comes to annuitizing GMIBs.

GMIB payouts are the insurance industry's version of second-rate income annuities. This might be okay if consumers clearly understood the fact when they are evaluating the GMIB option

However, I have never seen GMIB marketing materials that clearly disclose or compare differences between GMIB annuitization and the same company's other annuity payouts. Despite the vast attention regulators have paid to VA sales practices, I am not aware of any regulatory authority that has required clear consumer disclosures in this area, despite the fact that GMIB purchases are irrevocable in many cases. (The rider and its continuing cost can't be cancelled without surrendering the contract.)

Step 1: Comparing Amounts

Here's Step 1 of the analysis:

• Ask the client to obtain from the insurance company (or a recent statement) three pieces of information: 1) the current VA contract value; 2) the current GMIB Benefit Base; and 3) a quote for monthly annuity payout if the GMIB is fully exercised now. It's also a good idea to obtain the "window period" for annuitizing under a GMIB, since most companies restrict exercise to one window per year.

• Take the client's current VA contract value and "shop it" among competitive carriers for an annuity quote comparable period to the payout of the GMIB payout method. This will help the client quantify whatever value the GMIB offers. For example:

Current GMIB Benefit Base: $140,000

Current VA contract value: $80,000

Monthly income on GMIB annuitization at age 65 (life annuity): $657

Best immediate annuity quote on $80,000 (life annuity): $541

In this example, the GMIB provides a bit above $100 per month more than a "market rate" annuity, so it has some value.

Step 2: Determine Internal Rates of Return

Step 2 converts each quote (above) into an internal rate of return over the annuitant's life expectancy. In my book The Complete Rollover Guide for Financial Professionals, I describe how to do this calculation in Excel step-by-step. (See the box at the end of this article for a summary.) I believe in using the online Period Life table published by the Social Security Administration to determine life expectancy (by sex) for this purpose. It is updated annually and located here:

• http://www.ssa.gov/OACT/STATS/table4c6.html

This table is more accurate for the general U.S. population that mortality tables used by life insurance companies because it includes millions of lives, compared to the much smaller (and healthier) sample of immediate annuitants built into industry tables.

The table below shows results of converting the two annuity quotes obtained in Step 1 into an internal rate of return, using the current Social Security life expectancy of 19.5 years for a 65-year-old female.

The client can see that the GMIB payout in this example represents a 0.98% internal rate of return over life expectancy, based on the $140,000 benefit base, while the competitive market is paying 5.24% on the $80,000 contract value. Now, the table is set for more extensive analysis.

Step 3: Evaluating the Fine Print

Step 3 involves looking closer at the fine print of the VA to evaluate other options. Here are three examples:

• A "dollar-for-dollar" withdrawal benefit. Any withdrawals made from the VA have an offsetting impact on the Benefit Base. (Withdrawals may be limited to the percentage annual increase guaranteed in the Benefit Base.) For example, in the example above, the account holder could withdraw $40,000 from the Benefit Base and still retain the option of annuitizing $100,000.
• An option to increase contract value to benefit base. A few contracts offer a one-time option (after a waiting period) to increase the contract value to match the Benefit Base. Exercising this option cancels the GMIB and all rights pertaining to it. For example, in the example above, the contract value could be increased to $140,000.
• Enhanced death benefits. It's important to realize that all VAs with GMIBs include two embedded options, each of which can be valuable, but only one of which can pay off. In addition to the GMIB, look for an enhanced death benefit that has grown substantially above original deposits and contract value.

Step 4: Client Circumstances and Needs

Step 4 focuses on the client's retirement situation and objectives, with special attention to four areas.

• Inflation Concerns – Pension and annuity payouts are vulnerable to high rates of inflation, so ask clients how worried they are about big increases in their future costs of living. Also, determine what part of their total retirement income consists of fixed pensions or other annuity payouts. Most retired people should not have more than 50% of their incomes fixed and vulnerable to higher inflation.

• Taxes – In previous columns, I've explained how retired people can face even higher income tax rates than younger people. See:

The Value of Flexible Untaxable Retirement Income

With the vast federal borrowing and spending programs of the current recession, it has become more likely that future Social Security benefits of affluent retirees will be "income-related," as Medicare benefits already are. To understand why income-relating creates greater income tax impact, see: Help Your High-income Senior Clients Plan for New Tax Complexities

Step 5: Making a Choice

Here are several choices that clients can evaluate in this analysis:

1. Annuitize now. Convert 100% of the Benefit Base into annuity payments.
2. Withdraw now, annuitize later. Take a dollar-for-dollar withdrawal (if available) and postpone the decision to annuitize. This can be attractive if age-reduction factors will decline over time, or if the client has not yet finished the 7-10 year waiting period before GMIB annuitization is allowed.
3. Transfer and annuitize. If a competitive annuity quote is better than the GMIB rate quote, it can be accessed by making a tax-free annuity-to-annuity exchange and then annuitizing. Be sure the new insurance company is at least as financially strong as the old.
4. Do nothing. A contract with a 6% guaranteed annual increase in the Benefit Base and a dollar-for-dollar withdrawal privilege is equivalent to a 6% guaranteed savings account. If clients don't need current income, doing nothing may be the best choice, especially if they: 1) are in good health and expect to live a very long time; 2) would like to defer taxable income. Make sure clients know the contractual age limit for exercising GMIBs.
5. Let an enhanced death benefit pay off. If clients are old or not in good health, it may be advisable to let the second option embedded in the contract, the guaranteed death benefit, pay off. This choice can make sense if an enhanced death benefit is substantially higher than contract value. Any withdrawals will only reduce the death benefit dollar-for-dollar.
6. Estate-building strategy. Determine the amount of death benefit that the client would like to leave to their heirs income-tax free. Annuitize enough of the benefit base (or contract value) to fund permanent life insurance premiums for a policy with a death benefit in the same amount. Then, let the remainder of the policy accumulate tax-deferred and pay out the greater of contract value or death benefit at the annuitant's death. The tax-free life insurance proceeds can be used by the VA beneficiary to pay income taxes owed on the death benefit.
7. Go to cash – If clients are not under water by much in their VAs and also are concerned about insurance company financial strength or higher inflation, it can be feasible to take a full withdrawal, put the money in cash for a year or two, and then shop around for annuity quotes ? perhaps at higher rates. In a year or two, we will know better how much damage the downturn has done to insurance companies and which ones have survived in strongest condition. The internal rate of return analysis described in step 2 of this process can help to compare the rates embedded in annuitization with current CD, bond or money market rates.

In Summary

Some VA owners may be in a panicky mode right now because their contract values are falling, and they may think GMIB rights will expire or evaporate if they don't take action. This is rarely true except at fairly old ages. In many cases, clients have a great deal to gain, and not much to lose, by taking time to make up their minds.

As inferior as GMIB payouts are to competitive immediate annuity quotes, they still will increase with each year of advancing age. And if interest rates rise from today's fairly low levels, competitive immediate annuity quotes will get better. The ability to meet current liquidity needs with dollar-for-dollar withdrawals can be very attractive in some cases, and withdrawals may not greatly affect future annuitization choices available under GMIBs.

Above all, this service will show that your primary loyalty is to the client – not insurance company products ? and you are willing to help clients cope with difficult decisions as well as attractive opportunities.

How to Turn an Annuity Quote into an IRR in Excel

Any annuity payout over a defined number of years, purchased with a single sum, can be converted into an internal rate of return. For example, a 20-year payout of $700 per month, purchased with a $100,000 sum, converts to an annualized rate of return of 5.87%. In Excel, you can build a quick calculator of annuity rates as follows:

Boldfaced cells are for input.

• The formula in cell B4 is:

  =RATE((B3*12),B2,-B1))

This formula uses Excel's RATE function to convert the stream of payments into a monthly interest rate.

=POWER(1+B4,12)-1

This converts the monthly interest rate in B4 into a compounded annual rate.

In a lifetime annuity payout, there is no fixed period to evaluate because death could occur (and payments stop) at any time. A good starting point is to use the annuitant's life expectancy for the payout period.

Communication Opportunity for Older Clients

For clients who are age 70 or older, Congress has created an option to avoid taking minimum distributions from retirement plans and IRAs for 2009. This means that a client need not take any distribution prior to 12/31/09, based on the account value as of 12/31/08. However, for clients who have until April 1 of 2009 to take their first minimum distribution (for 2008), because they turned 70 1/2 during 2008, the minimum distribution is not waived.

Example: John turned 70 1/2 in 2008 and must take the first minimum distribution by April 1 of 2009. This first distribution has not been waived, but the second distribution (for 2009) has been waived.

Make sure your clients understand this opportunity.