The newest feature annuities are promoting is the Guaranteed Minimum Income Benefit Rider, or also known as the Guaranteed Minimum Withdrawal Benefit Rider, or simply the Income Rider, which we will use in this analysis for simplicity’s sake. Let’s take an in-depth look at just how these riders work and see if it is something you should have.
Originally annuities were designed to provide a guaranteed income for life to the annuitant with the development of the immediate annuity. An immediate annuity requires a cash deposit to be annuitized, or converted to an income stream, and is no longer available as a lump sum, which is an irrevocable decision. This can leave the beneficiaries with little or nothing, depending upon which payout option is chosen. In most cases it isn’t always the best decision for the client and their families.
The income rider does what the immediate annuity was designed to do, which is to provide a guaranteed lifetime income, but unlike the immediate annuity, it is not an irrevocable decision, the cash deposit is allowed to grow, and whatever is still left in the annuity at death goes to the heirs. It truly has provided a much better alternative for the majority of consumers than the immediate annuity. Surprisingly the income payments are very close to what one would expect from an immediate annuity, without the negatives.
History of the Income Rider
The income rider had its origins in the early 2000’s within the variable annuity marketplace. Over the next few years, many variations of these were developed. After the major stock market selloff in 2008-2009 created significant pressure on many of the variable annuity companies’ reserves, many of the companies reduced them, or quit selling them altogether. About that time the index annuity industry adopted the income rider, and since an index annuity can never have a losing year, it quickly has been the perfect product for the income rider, overall providing much higher payouts than variable annuities.
How They Work
To understand an income rider, you have to picture your annuity with two separate accounts, the actual account value and the income value. The account value in an index annuity will simply be your deposit, plus bonus (if any), and index gains, minus rider fees (if any). Since the returns are based on market indexes, such as the S&P 500, there is no way to predict the actual value. Keep in mind this is your true money.
The income value in contrast is really a fictional account (assuming this is not a true benefit rider, more on that later, see further posts). It is a figure used for an accounting function, and is NOT available as a lump sum or can be accessed for cash. It is just used to CALCULATE FUTURE INCOME. If you have ever been told you will automatically earn 6 or 7 percent guaranteed on your investment, unfortunately you have been told incorrectly which gives us two conclusions; you didn’t understand this when the agent explained it to you, or your agent is dishonest and frankly should have his license revoked. It is critical for the agent to always disclose clearly to clients exactly how products work and clear up any false claims that are being made in the sales communities.
So let’s dive in and see how this works:
Let’s assume you deposit $100,000 into a fixed index annuity and it has an 8% bonus. Your account value and income account will both be $108,000. Lets suppose you wanted to wait for 5 years and start your income in the beginning of year 6, when you and your spouse are now both 65. So the math works like this: simply compound the $108,000 at the income rider growth rate (say 7% for this example). After 5 years the income account will be worth $151,475.59.
Next we need to calculate the annuity payout rate which IS VERY IMPORTANT and they differ greatly among companies! (We can point out if the annuity you’re looking at is competitive). Let’s say the joint life payout rate is 5.0% for example. We simply take 5.0% of $151,475.59, which is $7,573.78. At this point you now exercise the Income Rider and your annuity will guarantee income for as long as either one of the spouses lives. This is a very solid planning strategy to make sure you don’t outlive your money with guarantees.
So let’s look at what is happening to your actual money, or the account value. Each year $7,573.78 is being withdrawn from the account, and also any index gains you may receive will be added, and any rider fees will be deducted. Keep in mind you cannot have an index loss in a fixed index annuity (See article on Mechanics of an Index Annuity: How They Work).
If the account value was worth $120,000 dollars at the time of the withdrawals, then the account value would go to zero somewhere between the couple’s mid to late eighties, assuming returns similar to the past 10 years. This of course is just an estimate so for disclosure purposes past performance is no guarantee of future returns.
Now if either one of you is still living, the lifetime income WILL CONTINUE even if the account value goes to zero for the duration of your lifetime. If you should both die earlier, whatever is left in the account value will be paid to your beneficiaries.