For many retirees and soon-to-be retirees, if there’s one nagging worry that tops all others, it’s that they might run out of money someday.
Their fear is not unfounded. Americans are living longer. The number of employers offering pensions is dwindling. And there’s a growing concern that Social Security benefits may have to be curtailed if the government can’t get the federal deficit under control.
Most people understand that they may have to rely heavily on their savings to make ends meet. And they’re looking to set up reliable income sources they can depend on for a retirement that could last decades. Which is why, in recent years, annuities customized with income riders have become a popular option.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
An income rider, or living-benefit rider, is an annuity enhancement that’s designed to deal with longevity risk by ensuring that you can count on a regular income stream regardless of how the markets perform or even if you live long enough to drain all the money from your account.
Sounds straightforward enough. Unfortunately, the contracts, fees and calculations that determine how much you’ll actually get in income can vary from carrier to carrier, and some companies market their income riders in a way that I (and many others) feel is purposely misleading. You could lose more than you gain if you don’t know what to look for in the contract.
If you think an income rider might be right for you — or if your financial adviser or insurance agent is recommending one as a part of your retirement plan — here are a few basics to watch for and to ask about:
The roll-up rate vs. the payout rate
Often, carriers will advertise an income-rider rate — maybe 7% or 8% — that seems too good to be true. And, in a way, it is. That number, usually called the “roll-up rate,” grows your benefit base every year until you activate the income rider. But it’s only part of the story. The benefit base is a phantom account — it isn’t the true account value of the annuity, and it isn’t yours to withdraw anytime you like. The payout rate — the percentage of the account value that actually will be paid out in the form of lifetime income — is just as important to know, because your payment will be that rate times whatever the benefit base has grown to.
People often think an income rider with a roll-up rate of 8% is automatically better than one that is 5%, but that’s not necessarily so. You have to factor in the payout percentage to get the full picture.
Because the purpose of the income rider is to guarantee the highest payments possible at some point in the future, you’d think the payout rate would be a marketing priority. Instead, the roll-out rate gets all the love. So, what’s a good consumer to do? Ask for both percentages and run the numbers to be sure you’re getting the maximum payout at the age you plan to turn on your income stream.
The annual fee vs. the guarantee
Most income riders come with an annual fee — usually about 1%. So the more you accumulate in your account, the more you pay. In exchange, the insurance carrier is taking a chance that you might live longer than it expected and will guarantee you’ll keep getting income even if your account runs dry.
Historically, the point at which that typically happened — when the insurance carrier crossed over from simply returning your own money to paying out of its pocket — was about age 80. But now we’re seeing that crossover point being pushed back for many people who have income riders, and the money isn’t coming from the insurance carrier’s coffers until annuity holders reach their 90s.
Ask yourself if it’s worth paying the fee for years ($2,000 a year for a $200,000 annuity, for example), if you won’t benefit from the rider until you reach that age.
The fee vs. the limited upside potential
Another factor you may have to compromise on with an income rider is the “cap”: the maximum amount you’ll be able to earn based on the market index your “real money” account value is tied to.
With a regular fixed index annuity, the cap would likely be around 6%. So, if the index was up 10%, for example, your account would be credited 6%. If the index was up anywhere between 0% and 6%, you’d be credited with that percentage. And if the index was below 0%, you would get nothing. You wouldn’t make any money, but you wouldn’t lose, either.
But with most income riders, the cap is much lower — closer to 2% or 3%. Subtract the 1% fee, and you’re making even less. And if the index is below 0%, you will, in fact, lose money because you still will have to pay the fee.
The tax-deferred benefits vs. taxable distributions
One of the most attractive features of using an annuity for retirement can be the tax advantages it provides. If you decide to fund a non-qualified annuity, for example, one positive is that it will grow on a tax-deferred basis — meaning you won’t pay taxes on the growth until you start withdrawing money. But if you have an income rider, when you start taking the pension-like income benefit it provides, it will count as a taxable distribution until you get back down to your original deposit. And those funds will be taxed as ordinary income, not long-term capital gains, which are usually lower. That added income could land you in a higher tax bracket, which could trigger taxes on your Social Security benefits and/or increase your Medicare costs.
This isn’t to say that all income riders are bad. After talking to an experienced financial professional and/or tax adviser, you may find that an income rider is the right choice for you. If you’re someone whose only guaranteed income stream in retirement is a small Social Security benefit, and you’re looking to fund your own pension-like income stream that you’ll know will be there forever, it may make sense.
But I’ve met with many retirees who pay a substantial fee, year after year, for an income rider they will never use. (There are several reasons why they might not use it: For most, it is because they have other assets that make more sense to take distributions from over the annuity. Death would be a reason too.) Meanwhile, they’re limiting their earning potential and possibly adding to their tax burden.
Ask your adviser about other ways to create an income stream without using an income rider. And, first and foremost, know what you’re getting, what you’re giving up and how it all fits within your overall retirement plan.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
-
Stock Market Today: Cautious Investors Let Stocks Drift LowerMarkets weigh encouraging trends for earnings and tariffs against concerning signals from U.S. consumers.
-
A Smart Way to Combat Economic RollercoastersSavings With rates on CDs remaining high for now, a CD ladder allows you to maximize your returns with flexibility to your cash when you need it.
-
Time to Spring-Clean Your Finances: A Financial Professional's Four Steps to Tidy Them UpA midyear review of everything from spending to saving, with adjustments as needed, can set you on track to financial security. Plus, don't forget to check in on your workplace benefits.
-
Why a Law Firm Secretly Recording Client Conversations Is Wrong (and Illegal)A law firm that has been recording client conversations without the clients' knowledge or permission and has threatened employees if they speak out faces legal and ethical challenges.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
