The Fixed Index Annuity Income Riders

July 28, 2008

SOURCE: InsuranceNewsNet, Inc.

Annuity income riders are designed to provide safety of investment, predictable, guaranteed, lifetime income and peace of mind to people who are worried about running out of money in retirement.

How does the guaranteed income rider work? An annuitant has the option to surrender his or her principal in exchange for a series of guaranteed lifetime payments. Most annuities do not allow people to make substantial withdrawals once annuitization of the contract begins. For example, an investor has started receiving $1,200 every month from his or her contract. Shortly after, the investor decided to buy a new car and withdraw $20,000 from his or her annuity. Typically, annuities will not allow this.

The guaranteed income rider allows the investor to make withdrawals for life while retaining access to principal. If an investor deposits $100,000 in an annuity with a 5 percent lifetime-income rider, he or she can withdraw $5,000 annually for life, even when the account balance has been depleted. The investor can stop taking those withdrawals whenever he or she wants and still have access to any money remaining in the contract.

According to some financial planners, a fixed indexed annuity with an income rider can effectively cover a specific income gap in a client’s retirement income stream more efficiently than a diversified portfolio. This is because even a diversified portfolio can fluctuate in value while a fixed annuity is insured against that. Even at 5 percent – widely considered as a safe withdrawal rate on a well-diversified portfolio – unpredictable market movement can dramatically affect its performance.

In fact, a fixed indexed annuity with an annual cap of 8 percent has consistently outperformed the FTSE 100, Dow, S&P 500, and the NASDAQ from 2000 to 2007. In comparison, a well-diversified portfolio valued at $100,000 using a withdrawal rate of 5 percent would have fluctuated by as much as 41 percent between 1988 and 1997 using the S&P 500.

This stability gives investors the freedom to use other resources more freely and aggressively in stocks with potential for higher long-term returns as the fixed index annuity safely covers basic income needs regardless of the portfolio’s yearly return. Experts say even with the annuity fees and expenses, annuities with guaranteed income riders will outperform most portfolios many investors create on their own.

For example, a 70-year-old man has a $100,000 in fixed indexed annuity for 10 years. At 8 percent guaranteed interest rate, the annuity’s guaranteed income account grows to $215,892, generating a $17,271 guaranteed lifetime income.

During that period, the account earns only the guaranteed minimum surrender value of $128,208 because of poor index performance. But because the client selected a guaranteed lifetime income he will be able to withdraw $17,271 annually for the rest of his life even if he exceeds his normal life expectancy. If the investor’s normal life expectancy is 88 years but he lives until 98, the average rate of return for his fixed annuity would be 4.9 percent.

Of course, there is a downside to annuities with guaranteed income riders.

The rider is applicable only to the annuitant and not his or her beneficiary. Generally, the death benefit of annuities with this rider is equal to the remaining account value or any original principal still not paid back.

Generally, income riders do not provide high guaranteed income and safe cash accumulation. It only provides one or the other.

Also, once the guaranteed income starts, the income is withdrawn from the indexed account because the guaranteed income account no longer exists. In fact, the $215,892 in guaranteed income amount in the hypothetical example here is simply a basis used in calculating the $17,271 annual lifetime income and does not really exist.

If the investor decides not to take the lifetime incomes option after all, he or she forfeits the cost of the rider, which may be as high as $8,000.

Still, overall, many experts believe the advantages of guaranteed lifetime income riders are worth the extra cost. But it is important for advisors who want to market these riders to understand their limitations before offering them to their clients or prospects.

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