Risk adverse investors wanting to accumulate funds that can later be turned into a reliable lifetime stream of income during retirement should consider a guaranteed annuity income rider.
Most often these riders are attached to fixed and fixed-indexed annuity policies, but they are also part of newer variable annuities as well. For the sake of conservative investing and fee avoidance, this article will focus on income riders that are attached to non-variable annuity accounts.
How Do Annuity Income Riders Work?
Income riders offer a yearly guaranteed percentage roll-up on the invested principal - usually in the 7%-8% range. In some cases, the income account value will also benefit from a premium bonus if the chosen fixed or indexed annuity offers a first year bonus.
The income account value will increase every year by the guaranteed percentage increase offered by the insurance company's income rider. In this way, the roll-up amount is locked in and won't change while the account is in deferral. Most income riders allow for a maximum of 20 years of deferral.
When desired, the annuity owner can activate the income rider and begin taking a lifetime income stream from the account. The longer the funds have been in deferral, the larger the payout.
Usually, the account must be in deferral for at least one year before payments can begin, but it is much more advantageous to defer the income for a longer period of time before activating the income rider.
What Variables Affects The Payout Amounts?
The guaranteed roll-up percentage, any applicable premium bonus, and years in deferral will all affect the available future payments.
However, one of the most important variables affecting payments is the allowed withdrawal percentage once the income is activated. Each insurance company will allow for different withdrawal percentages at different age bands.
Thus, if insurance company A offers a 7.2% guaranteed roll-up, but only a 4% future withdrawal percentage, then insurance company B offering a 7.0% guaranteed roll-up and 5% future withdrawal percentage will likely illustrate much higher future payments.
Ultimately, all of these variables are known quantities and provided by the insurance company at the time the rider is purchased. By working with an independent annuity broker, investors can request several illustrations in order to secure the highest guaranteed future income stream.
Can Future Income Payments Account For Inflation?
Future payments will be determined by the type of income rider that is purchased. Some income streams are stable meaning the future income payments will never increase while others will increase by a predetermined compounding factor of 3% for example.
When a compounding annuity income rider is purchased, then the initial payments will be smaller than an account with a stable income stream - assuming all other factors are equal. However, the compounding stream of income will eventually surpass the stable stream of income helping retirees keep up with inflation.
What Is The Cost Of An Income Rider?
The cost will vary from company to company and can also be affected by the annuity that it is ultimately tethered to upon purchase.
Most income riders cost somewhere between thirty to seventy basis points each year and this amount is withdrawn from the accumulated value of the chosen annuity. There are a select few insurance companies offering smaller roll-ups (5% for example) at no additional cost to the policy.
The income rider cost is only assessed to the walk-away value of the account. In this way, the income stream is never affected by the cost of the rider. Rather the annuity itself is assessed the fee.
If the annuity income stream was never taken for some reason, then the walk-away value to the owner (or the owner's beneficiaries) would be less than the value of the exact same annuity without an attached income rider.
What If I Don't Activate The Income During My Lifetime?
The accumulated funds do not disappear nor does the insurance keep the annuity value upon passing or surrender.
Annuity owners who have purchased an income rider must understand that there are two account values at work. The first is the walk-away value and the second is the income account value.
If income is never taken, activated then later deactivated, the owner passes away, or there is accumulated principal remaining, then there will be available funds for withdraw for either the owner(s) or the owner's beneficiaries.
In some cases, the owner may simply withdraw the entire accumulated value (minus any applicable surrender penalties) and choose to invest the funds elsewhere.
If the owner passes away and principal remains or no income has been taken, then the beneficiaries can withdraw the accumulated annuity value lump sum or the larger income value over a set number of years.
Either way, the insurance company does not keep the remaining funds for themselves. However there are two points to consider:
- The owner cannot walk-away with the income account value to invest elsewhere - only the accumulated annuity value is available.
- The annuity may have distributed enough income during the owner(s) lifetime leaving little to no proceeds for the beneficiaries.
Annuity income riders can play an important roll in providing stable growth of principal and guaranteed income during retirement. It is wise to seek the guidance of a knowledgeable, independent annuity professional before purchase.
Potential investors should request detailed illustrations in order to best understand income availability, account values, and future proceeds.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am an independent insurance agent offering various types of annuities and retirement planning strategies direct to consumer in several states across the country.