The modern financial landscape for today's retirees is quite different from that of prior generations. Corporate pensions are disappearing, and the Social Security program faces new pressures from record-breaking numbers of people retiring.
Annuities have steadily emerged as a solution to these retirement income challenges. But up until some years ago, many retirees eschewed the use of annuities. Why? Because in order to get a guaranteed lifetime stream of income, they had to annuitize their contracts.
In order to do this, they had to effectively forfeit control of their money for the rest of their lives. Thankfully, life insurance companies have innovated and come up with a new benefit that gives more flexibility: an annuity income rider benefit.
The Guaranteed Income Revolution
In response to evolving annuity customer needs, insurance companies have created this new benefit called a guaranteed lifetime income rider. A guaranteed lifetime income rider is an add-on to a base annuity contract, which means it’s often an extra guaranteed feature to be added to your contract.
However, some base annuity contracts do include an income rider benefit in their contract bodies. This type of rider has many different names, including:
- Guaranteed minimum withdrawal benefit
- Guaranteed lifetime withdrawal benefit
- Guaranteed lifetime benefit rider
This rider allows annuity owners to retain at least a measure of control over the money in their annuity contracts while still guaranteeing a steady payout. And it isn’t necessary to annuitize the contract in order to use this type of rider.
One way to think of the income rider is as an add-on to a house. The base annuity contract is the house, and the rider is an additional room that is included.
How Much is the Cost of a Lifetime Income Rider?
This type of annuity rider usually also comes at an additional cost. Many annuity contracts will charge a 0.95% annual fee for this benefit – or in other words, 95 basis points per year. A basis point is 1/100th of one percent.
In most cases, this cost is charged to the base cash value in the contract. So, yes, it slows down the actual rate of growth in the annuity.
But in return, the rider will guarantee a lifetime payout based upon a preset rate of return built into the rider. And unlike with annuitization, where you have converted your money into an irreversible set of income payments over time, you still retain some control over your money with the income rider.
In other contracts the rider may just be built into the contract. Or it may simply come at no extra cost at all.
What Does an Annuity with an Income Rider Do?
The purpose of a lifetime income rider is to provide another form of a guarantee for lifetime income.
The income rider ensures that you will receive an income stream that is contractually guaranteed for the rest of your life. You are guaranteed these payments for life even if the money in your contract runs to zero.
How much in payouts you receive will depend on your age. The older you are, the higher your guaranteed payouts will be. The insurance company doesn’t have as much risk to manage then as it would at younger ages.
Annuity Lifetime Income Riders Differ by Insurance Company
Lifetime income riders can vary from insurance company to insurance company. Not only that, they may differ from contract to contract.
Life insurance companies have different ways of structuring their lifetime income rider benefits, including how the benefit grows. They often also have differing terms of condition for a lifetime income rider benefit in their particular annuity products.
Overall, the goal of an income rider benefit is for you, the retiree, to be able to enjoy more guaranteed income in exchange for a lesser amount of money in your contract. That way you don't have to put 'as much' money into the contract.
In other words, you are effectively buying more guaranteed income for a reduced price when you purchase an annuity with an income rider.
The insurance company might charge a rider fee on your money for the income rider benefit. But if your annuity provides a guaranteed income as part of an overall retirement strategy – and that is its primary role in this strategy – this paid-for guaranteed benefit can be well worth it.
Your assets in the other parts of your portfolio can have growth potential to offset the fee charges. And don’t forget, your annuity contract can let your money grow, too.
Advantages of Lifetime Income Riders
The first and most obvious benefit that these riders provide has already been mentioned. Clients can retain at least some control of their money even after this type of rider kicks in and begins making payments.
Other benefits of an annuity income rider include:
- Some contracts allow the annuity owner to turn the rider on and off as needed.
- If the income rider does come at a cost and is charged to the base value in the annuity contract, some contracts will allow the rider to keep making payments even if the annual fee for the rider reduces the contract's cash value to zero.
- The insurance carriers are the ones taking the actuarial risk with these riders.
- Annuity owners who live to a ripe old age will keep getting their monthly mailbox money even if they have depleted the entire value of their contract, just as they would if they had annuitized the contract.
Some other potential benefits of an annuity with an income rider include:
- Some annuity contracts that have income riders will credit the contract with a big bonus upfront.
- This 'income bonus' then increases the amount that the insurance company uses to calculate the amount of the monthly payment under the rider.
- This type of bonus effectively allows the contract owner to enjoy a higher stream of income at a lower cost than they would incur from other alternatives such as a bond ladder or CD ladder.
Disadvantages of Lifetime Income Riders
As mentioned previously, the most obvious disadvantage of an income rider is the additional cost. While not all contracts charge extra for this feature, most of them do.
In some cases, this annual charge can bring the actual cash value in the contract down to zero. While some contracts will continue to pay out if this happens, some don’t, and those in the latter category are then left with nothing.
Annuity owners need to find out how much they will pay for this rider before purchasing the contract. Other disadvantages include:
- The details of how income riders work can be quite complicated in some cases.
- It can be difficult for uneducated buyers to understand exactly how the rider works and how they are paying for it.
- Some annuity contracts have certain requirements before the rider can be used. For example, the annuity owner may have to hold the contract for a certain minimum number of years before they are allowed to turn the rider on.
- The period of time where income is deferred in the contract and the insurance carrier is crediting interest to the income base value is known as the "rollup period.” The interest that is credited is called the "rollup rate."
- The income rider may guarantee the rollup rate for a certain period of time, but the rollup rate may be lower once that time period is over.
- There might be age restrictions on when you can get the rollup -- such as it being obtainable starting in your 60s and up to mid-80s.
- There may be other "gotchas" that can come with this, so be sure to check those with your advisor before any purchase.
Some other disadvantages which you might see in an annuity with an income rider are:
- Although an income rider may allow you to turn income on and off, there may be restrictions as to when that can happen. Check your policy or ask the person who sold you the contract for details.
- The method the insurance carrier uses to credit growth to the income benefit of the annuity contract may not be very clear in many cases. This is because the carrier may use a complex actuarial formula to determine how much growth to credit to the contract.
- Some income riders base the growth rate on a percentage of the lump-sum payment made into the annuity. Others use some sort of weighted interest rate.
- Still, others use simple-interest crediting and therefore a fixed number for growth over a certain period of time (for example, a simple interest-crediting bonus for each contract anniversary year).
Because income riders -- and the interest credited to your income value in your contract -- can be confusing, this can open the path for misleading marketing. Or it can lead to sales of a contract that the agent doesn't really understand.
As always, be careful and know what you are buying with an annuity before you commit to the purchase. Don't be afraid to ask your financial professional questions about anything that you don't understand, that confuses you, or that concerns you.
Finding the Right Annuity with an Income Rider
Guaranteed income riders can ultimately resolve the dilemma that annuity owners faced in the past. Back then, they would have to effectively forfeit all control of their money in order to get a guaranteed lifetime payout.
An annuity can possibly help your retirement future in many ways. But the details surrounding how these riders work, and their limitations, can be quite complex in some cases.
Be sure to consult with your financial advisor about how the income rider in a given contract works before you buy anything.
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