What to Know Before Purchasing an Annuity Income Rider
Do you know the difference between a GLWB and a GMIB? A roll-up rate and a payout rate? If you're contemplating a fixed indexed or variable annuity with an income rider, make sure to understand the key terms so you can effectively compare your options and see which offers the best bang for your buck.
For over a decade, annuities with income riders have become a preferred choice for many retirees without pensions or in need of supplementing their Social Security. Who doesn’t want a “guaranteed return” of 5% to 7% and as high as 10% for the next 10 to 15 years without having to go through the stock market roller coaster?
I use quotation marks here because that’s what many financial advisers or insurance agents overselling variable and fixed indexed annuities with income riders are promoting in order to sell you. And the worst part is the adviser might not be more knowledgeable on how the product works than you are. This is why most retirees who have this feature typically don’t fully understand how it works. (Learn more by reading “Are Annuities a Solution for Baby Boomers in Retirement?”)
A lot of marketing gimmicks have diluted the principal reason why you’d use an annuity income rider: to get the highest payout for the least amount of money invested. These products need to be explained better.
What is an annuity income rider?
Simply put, an annuity income rider — often referred to as a “guaranteed income benefit rider” or “lifetime income rider” — is an enhancement that can be added to most fixed indexed and variable annuity contracts. Its sole purpose is to create a payout that is contractually guaranteed for the rest of your life (and possibly your spouse’s life as well), even if your original investment goes to zero.
The amount of the payment will depend on your age: The older you are when you “turn on” your income stream, the higher the payout will be. Since insurance companies use mortality tables to determine income amounts, an 80-year-old will always have a greater payment versus a 65-year-old.
But aside from your age, annuity payments can vary widely from insurance company to insurance company and from product to product based on a range of factors, including riders and the way the company structures its terms.
What are the 2 most common types of annuity income riders?
Whether the annuity income rider is a GLWB or GMIB, the distinct differences between both is withdrawals as opposed to annuitization:
1. Guaranteed Lifetime Withdrawal Benefit (GLWB)
The GLWB is an income rider found on both fixed indexed and variable annuities. With this rider, you’ll be guaranteed a percentage of your original investment as an income payment for the rest of your life (and possibly your spouse’s life as well), even if the account doesn’t have any more money.
For instance, a 65-year-old couple investing $100,000 who waits five years will receive a joint payout of $8,113 per year. If the husband were to pass away at age 82, his wife would still continue receiving the same payment during her lifetime. If she were to pass away at age 92, the total amount paid during those 22 years would be $178,486.
With a GLWB income rider, you can take predictable or occasional withdrawals from the annuity — offering more flexibility and control, and the annuity continues to grow instead of being locked in. The advantage of allowing it to grow while receiving withdrawals is a greater potential death benefit paid to a spouse or other beneficiaries.
2. Guaranteed Minimum Income Benefit (GMIB)
The GMIB is an income rider typically found on older variable annuities as well as some fixed indexed annuities. Similar to the GLWB, you’re guaranteed a minimum amount every year you wait to receive payments. However, the main difference is with a GMIB, you’ll eventually have to annuitize — or lock in — which effectively turns it into an immediate annuity for the rest of your life.
Again, the guaranteed percentage is the annual amount that’s credited to the annuity when it’s in deferral, but stops growing once activated. In comparison to a GLWB, it doesn’t offer the same flexibility to take withdrawals before annuitizing, so you will lose any control.
How much does an annuity income rider cost?
Most income riders cost around 1% per year that gets deducted from your accumulation value – which is the real value of the annuity if you were to terminate the contract or pass away. For example, if you invested $100,000 in an annuity, then you’d see at least $1,000 deducted from your accumulation value per year. When your annuity grows in value, the cost of the income rider goes up as well. In the same scenario, if the annuity grew 5% the following year, the income rider would cost $1,050 for that year.
It’s important to note that although one insurance company’s fee for a rider might be lower than another’s, for many insurance companies, once the fee is added to the annuity contract there is a chance it can never be taken off. This is the reason why you need to decide if it’s even worth having it on at all.
So, when comparing annuities, here are some terms that need to be included in your discussion:
What is the ‘roll-up’ rate?
The annuity income rider rate — often referred to as the “roll-up rate” or “step-up rate” — is the percentage at which the guaranteed side of an annuity (as opposed to the investment side) keeps growing as long it’s deferred. The word “deferred” is important, because obviously the longer you wait to start receiving benefits, the higher your eventual payout will be. Often, it is where you’ll hear financial advisers or insurance agents tout something like a “guaranteed 7% compound for the next 10 years.”
The income rider growth rate is isn’t exactly what it sounds like. It’s an artificial percentage (e.g., 5% to 7%) that an insurance company uses to calculate the increase in your account’s “benefit base,” which is the amount that you put into the annuity plus the roll-up growth. The money accumulating in your annuity’s benefit base is not something that you can walk away with. It won’t be available to you as a lump sum to withdraw: It merely represents the amount on which your payments will be calculated once you choose to leave the accumulation phase and start the payout phase.
Be careful, though, because as soon as you turn on the annuity income rider, the growth guarantee stops and now you’re in payout mode.
That “guaranteed” growth rate you’ve seen advertised is an enticing figure that most people tend to focus on when looking at annuities, but in some ways, another figure, called the payout rate, can be just as important — or more so.
What is the annuity income payout rate?
The income payout rate is a percentage of your annuity you will contractually receive for the rest of your life (and possibly your spouse’s life as well) based on your age. Your payment is essentially your benefit base multiplied the payout rate.
This number varies from each insurance company, and it’s something you should pay close attention to, because it could mean a big difference in your payment amount. Almost every insurance company has a different payout rate, so make sure to know this number before considering any annuity income rider.
An example of how it all comes together
- Insurance Company A has an annuity income rider with a growth rate of 8% compound and a payout rate of 4.5%. Five years after investing $100,000, your income account value is $146,933. At that point, you decide to turn on income with its payout rate of 4.5%. Per the contract, your payment would be around $6,612 per year.
- Insurance Company B has an annuity income rider with a growth rate of 5% compound and a payout rate of 5.5%. Five years after investing $100,000, your income account value is $127,628. At that point, you decide to turn on income with its payout rate of 5.5%. Per the contract, your payment would be around $7,020 per year.
If you only focused on the growth rate (which many people do), Company A looks more impressive than Company B at first glance. But, knowing to look deeper to the payout rate resulted in a $408-per-year increase.
While annuity income riders might seem like a really good idea, make sure they are absolutely necessary before adding any unnecessary fees to your contract. In my opinion, less is always more, and annuities are often oversold with all different types of riders — including income and death benefit riders — that can consume a substantial portion over time. At times, it may be even more advantageous to purchase an immediate annuity outright over an income rider.
To sum up, before purchasing any sort of annuity income rider, you need to know both the “roll-up rate” as well as the payout rate. If the financial adviser or insurance agent cannot give you multiple comparisons to prove the value of what they’re making recommendations on, it may be best to steer clear before making any sudden rash decisions without having all of the pertinent information.
About the Author
Founder and President, Dias Wealth LLC
Carlos Dias Jr. is a financial adviser, public speaker and president of Dias Wealth LLC, in the Orlando, Florida, area, offering strategic financial planning services to business owners, executives, retirees and professional athletes. Carlos is a nationally syndicated columnist for Kiplinger and has contributed, been featured or quoted in over 100 publications, including Forbes, MarketWatch, Bloomberg, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today and several others. He's also been interviewed on various radio and television stations. Carlos is trilingual, fluent in both Portuguese and Spanish.