When using an annuity for retirement income security, there are many questions that need to be considered. Annuities can pay you a guaranteed income for life, but they aren’t for everyone. They need to have a defined purpose in your retirement plan that solves a specific problem.
The annuity owner can determine when the annuity begins to pay out, and how the payouts occur. The payouts can occur for a fixed period of time, or they can be set up to pay out for the remainder of the contract holder’s life.
Done? Not yet. The financial professional offering you the annuity might suggest a series of additional benefits, called “riders,” which can be attached to your annuity. A rider can offer add-on benefits to your base contract. It can make the decision-making process even more involved.
Here are some of the types of riders you might find on a fixed index annuity. We will also answer some of the questions that can arise when you explore these riders.
Guaranteed Withdrawal Benefit
One key consideration to an annuity is how you might receive an income stream from the annuity contract, but still retain some liquidity. While annuitization, or converting your annuity money into an irreversible stream of payments, secures a guaranteed income source, you give up all access to your money.
One alternative, an annuity income rider can offer a balance between income and access. An income rider is often known as a guaranteed withdrawal benefit. Life insurance companies use names such as “guaranteed lifetime withdrawal benefit” or “guaranteed minimum withdrawal benefit” in their annuity products.
A guaranteed withdrawal benefit guarantees that someone will receive payments until death, often for a rider cost (but not always). These payments will keep going even if the annuity money goes to zero. What’s more, the annuity can continue to earn interest.
The annuity owner can stop and restart payments at any time, thus offering more freedom of choice than a pension. If the contract holder also needs some liquidity, they can take free withdrawals of up to a certain percentage from their annuity money.
On the other hand, free withdrawals can affect the payments that you receive with the guaranteed withdrawal benefit, as a trade-off. It’s good to keep that in mind if you choose to tap into your fixed index annuity for liquidity.
Lifetime Income Benefit Rider
A lifetime income benefit rider is another name for an income rider. This is similar to how an income rider can be called a guaranteed withdrawal benefit.
This rider guarantees a set regular income payment from the annuity, which can be designated to start at some time in the future, and can be paid out monthly, quarterly, or annually. The guarantee here is that the payments will continue until death, even if the principal is exhausted before that happens.
This can help as a strong defense against the danger of running out of money in retirement. Why might someone not want an income rider attached to their annuity? There are often rider fees, which usually cost around one percent.
It may also be a negative if you are looking to your annuity primarily for growth. In exchange for the lifetime income benefit, your annuity may have lower rates on it, limiting your money’s growth potential compared to what other annuities can offer. This enables the insurance company to be able to pay for the extended period payouts.
Death Benefit Rider
You might also consider certain add-on benefits for estate planning purposes. Yes, it’s possible for an annuity to pay a guaranteed income for the life of the owner. Additionally, a death benefit rider can be attached to the contract so that a final payment is made when the annuity owner passes away.
A death benefit rider allows for the owner’s heirs to receive at least the amount of principal premium paid for the annuity – a kind of return of premium. There is also a death benefit rider that allows for a multiplier on the contract value in case the owner passes away early. Some contracts with this rider benefit require for some years to have passed initially before it might apply.
It’s also possible to purchase a living benefit to heirs, transferring the annuity assets to a surviving family member.
As stated above, there are many choices. The cost is usually a percentage of the principal, paid on an annual basis.
Long-Term Care Rider
Think hard about this opportunity. Long-term care insurance is difficult to purchase these days, especially with underwriting, and is very expensive.
A long-term care rider allows for an annuity payout to be adjusted so that the annual payout can help cover the cost of long-term care. This rider usually covers a short period of time, such as three or five years. But it allows you and your family to have the funds they need to pay for the long-term care.
This rider is a good idea for someone who has a family history of living a long time, even in the case of advanced mental or physical disability.
However, riders differ based on contract details. Some contracts return to the original payout amount after the maximum allowable period for the long-term care withdrawals has passed (the suggested three or five years stated above). On the other hand, some contracts stop payments altogether if the original contract value has reached zero.
These details are often complex and need to be discussed with a financial professional before agreeing to any terms.
Cost of Living (COLA) Rider
Cost of living adjustment (COLA) riders aren’t exactly the most popular subject in town.
Nevertheless, with shocks to the economy by supply-chain and geopolitical changes, inflation has once again raised its ugly head. The cost of living is increasing, and thus, the need for a COLA rider.
An annuity contract calls for a guaranteed and specified monthly income. For a fixed index annuity, that income amount is typically the same every month. A COLA rider allows that amount to be increased based on a particular measure of inflation.
A caution: the company issuing the annuity gets to determine the inflation measure used. It might not be the best measure of current monetary value.
Some annuities allow for a fixed, annual percentage COLA increase rather than an annual determination of current inflation rates. Others allow for adjusting income depending on the fixed index annuity’s interest earnings, which vary and aren’t guaranteed.
In other cases, the income payout may be lower, in early years, on a COLA rider than if you went with a plain-vanilla annuity payout that doesn’t have increasing income. If that is so, it may be a number of years before the increasing income option catches up with this plain-vanilla level income option. Ask your financial professional to explain this in depth.
If you are looking at this option, ask your financial professional about the fine details of any rider benefits that you might tap to combat inflation. Don’t be afraid to ask any questions about something you don’t understand, and don’t feel pressured to move forward without understanding your options. This is your life savings, after all.
Some Final Food for Thought
This article only touches on some of the finer points of attaching a rider to a fixed index annuity contract. There are several other choices to be made.
Your options regarding an annuity should be discussed with your financial professional, who should be experienced and understand your personal situation well. If tax questions or other questions about your situation arise, bring in your tax advisor and other relevant professionals for personal guidance.
As you consider different rider options with any fixed index annuity you are exploring, it helps to keep these questions in mind:
- How is this annuity rider benefit solving a problem in my financial situation?
- Do I understand this fixed index annuity rider as well as its pros and cons?
- What am I giving up elsewhere in my annuity by opting for this rider?
- What does the rider cost all-in?
- What will be the cost of choosing not to go with that fixed index annuity rider benefit?
- Am I counting on this one annuity to cover too many potential issues in my retirement plan where it might fall short? (ex: lifetime income, long-term care, so on)
Like with any financial decision, you are putting money toward something that you hope will provide financial benefit to you for years to come. You want to make certain you are making the correct decision for your needs.
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It could be unwise to attempt to make those decisions yourself, unless you have a financial advisor or agent who understands these products and the issues they solve well.
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