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Introducing the home-made, lean and mean version of the hottest retirement investing product of the day.

The guaranteed minimum withdrawal benefit is an insurance industry creation that has attracted more than $18-billion on the promise of supplying retirement income for life, regardless of what happens in the stock market. Kiss the guarantee goodbye in the stripped down model of this product, and then say hello to lower fees, flexibility and the potential for higher returns.

Check out the Sept. 18 edition of the Portfolio Strategy column for a rundown on how guaranteed minimum withdrawal benefits work (read it here). The quick version is that GMWBs are for people who are petrified about stock market risk and willing to pay heavily for a guarantee they can annually withdraw 5 per cent of their retirement savings for life starting at age 65.

"A GMWB imposes huge costs for a guarantee and cash flow," said Ted Rechtshaffen, president and CEO of TriDelta Financial. "You can do virtually the same thing for thousands and thousands of dollars less."

TriDelta constructs its GMWB alternatives with a core of conservative investments that, while not guaranteed, can be considered safe. For a registered retirement income fund, the firm would start with a 5-per-cent weighting in cash and another 15 per cent in government bonds.

Corporate bonds and convertible debentures, a kind of bond that can be converted into stock, account for another 30 per cent. Utility stocks account for 25 per cent of the portfolio, while banks, real estate investment trusts and other high-yielding stocks make up another 10 per cent.

The final 15 per cent is where things get interesting because it involves segregated funds, the same product on which GMWBs are built. Seg funds, as they're usually called, are basically high-fee mutual funds with insurance company-backed guarantees that you will receive all or most of your money back after 10 years or when you die.

"Seg fund fees are expensive - at least more expensive than we like to have in client portfolios," Mr. Rechtshaffen said. "But there's value in them."

Why are seg funds no good in the GMWB, but okay in TriDelta's alternative approach? For one thing, the fees are lower. With a GMWB, you pay seg fund fees plus an additional guarantee fee that can bring the total cost to between 3 and 4 per cent. That's like saying your investments need to gross 3 or 4 per cent before you make a cent.

Also, GMWBs require you to build a relatively conservative portfolio using seg funds. Between the high fees on seg funds and today's low interest rates, you're not likely to make much of a return this way.

Mr. Rechtshaffen believes seg funds are an ideal vehicle for adding speculative content to a retirement portfolio that can bump up the overall return without adding much extra risk.

Let's conservatively estimate that you get an annualized 4.5-per-cent after-fee return from the 85 per cent of the GMWB alternative portfolio in conventional investments. Add a net return of 8 per cent from a 15-per-cent weighting in a seg fund focusing on emerging markets or small stocks and your overall return edges up to 5 per cent.

You can lock in your seg fund gains, too. Rules vary from company to company, but it may be possible to capture your gains in a high-flying fund by locking in profits twice per year. This has the effect of raising the amount to which the seg fund guarantees apply.

Mind you, it's possible to make 5-per-cent annually in a GMWB as well, through special bonuses paid in each year you're in one of these plans but not making withdrawals. But once you start taking retirement income out of a GMWB, the bonuses end and the value of your holdings can only be increased through portfolio resets that occur every three years. In other words, growth potential is limited.

You can set up a GMWB alternative portfolio on your own, but you won't be able to include the seg fund component. As with GMWBs, seg funds are sold by advisers who are licensed to offer insurance products and not widely available through online brokers.

Some options for working around this would be to boost the weighting of high-yielding dividend stocks or to buy a speculative investment without the seg fund guarantee. Even after the big losses of the financial crisis, some speculative sectors have posted solid 10-year gains. For example, natural resources funds have averaged 12.9 per cent for the 10 years to Aug. 31, while emerging markets funds averaged 5.7 per cent.

For investors assembling an alternative GMWB right now, rising interest rates are as much a risk as falling stock markets. "Every piece of this portfolio other than cash could fall in the short term," Mr. Rechtshaffen said.

Fear of short-term drops is what accounts for the success of GMWBs, and it's not to be dismissed. In fact, there's a new school of thought that the risk of ill-timed market plunges argues for the inclusion of a GMWB or an annuity (hand an insurance company a lump sum and have it paid back to you with interest for life) as part of a retirement portfolio.

Mr. Rechtshaffen said long-term market behaviour suggests the GMWB alternative is conservative enough on its own, though. When the components of the portfolio are combined, he wrote in an e-mail, "the principal is virtually assured based on the overall safety and decades of [market]history."

You can build a cost-effective GMWB alternative portfolio by picking individual bonds and stocks, or by using low-cost mutual funds. A cheap way of capturing the diversification offered by funds is to use exchange-traded funds that track stock and bond indexes. With the exception of convertible debentures and seg funds, you can buy all the components of the GMWB portfolio through ETFs.

Guaranteed minimum withdrawal benefits have become very popular as a retirement investment because they guarantee that you will be able to withdraw a set percentage of your svings for life. But GMWBs have hefty fees, and they're not very flexible. Looking for an alternative? Here's one designed by financial adviser Ted Rechtshaffen of TriDelta Financial, with his comments.

Asset

Weighting Reg. Account

Weighting Non-Reg. Account

Comments

Cash

5%

5%

High-interest savings accounts are used

Government bonds

15%

15%

Prefer bonds maturing in 5 to 8 years to maximize yield

Corporate bonds

15%

nil

Prefer bonds maturing in 5 to 7 years

Convertible debentures

15%

nil

Prefer those maturing in 3 to 4 years

Utility stocks

25%

25%

Dividend yields in the 3 to 4 per cent range

High yield stocks

10%

10%

Includes banks, telecom stocks and REITs

Preferred Shares

nil

30%

For dividend income, which is taxed more lightly than bond interest

Speculative seg funds

15%

15%

Look at sectors like emerging markets and small companies; look for 100% principal guarantee after 10 years and a 100% death guarantee

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