The Truth About Annuity Income Riders
01/16/2012 10:07 am EST
An extra guaranteed income stream may sound very attractive to potential annuity buyers, but few brokers outline all the facts. Stan Haithcock of StantheAnnuityMan.com explains what to look for if you're considering this benefit.
The hottest and most controversial topic in the annuity industry today is the Income Rider.
What is an Income Rider? It is an optional benefit that can be attached to an annuity for an additional annual fee, and will provide a lifetime income stream that you can turn on in the future.
Some Income Riders grow at a contractually guaranteed rate that will compound during the deferral years for future lifetime income. Other Income Riders lock in market gains that can be used for future lifetime income. Sounds great in theory, huh? Well, it can be...if utilized properly.
Income Riders work well when used properly and proportionally within your portfolio. The problem is that agents/advisors/brokers have used the Income Rider as the ultimate “sizzle” by focusing on the high percentage rate (without full explanation) to attract customers.
The common mistake/ploy that happens is that the annuity buyer thinks that the Income Rider rate is yield, and a number that they can walk away with in a lump sum. The typical phone call I get on a weekly basis is: “Stan, I have an annuity paying me 6% per year guaranteed.”
No, you don’t! You have an Income Rider that is growing at 6% per year, and can only be used for income. If that is the plan, then great, but you cannot access that total in a lump sum amount and go invest it somewhere else.
Income Riders should be used for what I call "target date income planning.” For example, if you need to turn on a lifetime income stream six years from now, you can use an Income Rider to guarantee a contractual growth rate that you can use for income at your planned income starting date.
The mistake that I am seeing people make is that they are attaching Income Riders to variable annuities, instead of fixed annuities. Most variable annuities put limitations on your investment choices when you attach the Income Rider to the policy, and you will also be charged higher fees. Income Riders attached to fixed annuties typically provide a higher payout rate with lower fees.
All Income Riders have 3 primary “legs to the stool”:
- The Rate. The percentage that is guaranteed during the deferral period.
- The Period. The amount of time that this rate is guaranteed during the deferral years.
- The Payout. The actuarial payout percentage that your lifetime income stream is based on.
Let’s break each of these components down so that you will have a full grasp of how Income Riders work, and what you should look for if you are thinking about utilizing this type of “target date” income strategy.
Most Income Riders offer a guaranteed contractual growth rate during the deferral period. These rates vary from company to company, but can be 5%, 6%, 7%, etc. Some companies even offer market lock-ins as an Income Rider.
Understand that all Income Riders have an annual cost attached, and that the guaranteed percentage number is not yield. In other words, you cannot “walk away” with the money. The Income Rider dollar amount can only be used for income.
When you attached an Income Rider to an annuity, the contract will guarantee that annual growth rate for a specific period of time during the deferral years.
Most contracts guarantee that growth rate for a ten-year time frame, and some will offer an extension to that time period if you want to defer or “target date” for longer than ten years. Once you turn the income stream on, the guaranteed annual percentage growth stops, and your lifetime income starts.
This is the most important part of the Income Rider structure, and it is almost never explained by most agents/advisors/brokers because there is no “sizzle” to this number.
When you decide to start taking a lifetime income stream from your Income Rider, the insurance company will base that lifetime payout on your age when you start that income. Common sense tells you that the younger you are, the lower the payout...and the older you are, the higher the payout.
The reason that Income Riders should be attached to fixed annuities instead of variable annuities is because the actuarial percentage payout rate is typically higher with fixed annuities. Also, the fees are much lower when you attach an Income Rider to a fixed annuity.
"The Payout” is more important than "The Rate,” and it should be the primary factor in your Income Rider decision. For example, an Income Rider rate of 6% might generate a higher lifetime income stream than an Income Rider rate at 7.5%, because "The Payout” is higher when you decide to turn on your income stream.
So don’t get caught up in the “sizzle” with Income Riders. Do the math, attach them to fixed annuities, and use them to plan for your future lifetime income needs.