For years, people purchased single premium immediate annuities or fixed annuities with the purpose of providing lifetime income. If you purchase a single premium immediate annuity (SPIA), your first payment must begin with the first 12 months. You can receive your payment monthly, quarterly, semi-annually or annually. The other option is to purchase a fixed annuity and “annuitize” the contract at some point. The insurance company often gives you an upfront bonus for the first year and possibly an “annuitization” bonus once you annuitized the contract. In a fixed annuity, the owner typically has to hold the contract for a minimum of one year or up to the end of the surrender charger period, depending on the terms in the contract. The contract would provide certain options you could choose from, such as period certain, lifetime only, lifetime with period certain, and occasionally a life with cash refund or installment refund option. The main thing keeping most people from annuitizing their contract, even when they need the lifetime guarantee, is losing control. Once annuitized, you are not allowed to make changes or additional withdrawals. In essence, all flexibility is lost.
What is an Income Rider?
Several years ago, insurance carriers began utilizing the Fixed Index Annuity to accomplish something very similar, but still provide the owner with flexibility. We will get into lifetime income features, but let us first take a look at some key aspects to understand about the Fixed Index Annuity. A Fixed Index Annuity allows you to “share in the upside of the market without sharing in the downside of the market”. There can be several features included in these contracts, such as the ability to make withdrawals up to ten percent, or required minimum distributions (RMD’s) for qualified accounts on an annual basis, typically after year one. Another benefit are Nursing Home Waivers (designed to provide up to 100% of the Account Value) specifying that when the insured is unable to complete two of the six activities of daily living for a specified number of days, the owner can access up to 100% of the account value. The third popular waiver is the terminal illness waiver which states if the insured is diagnosed with a terminal illness and given twelve months or less to live, the owner can also access up to 100% of the account value. Insurance carriers do this because they understand it is a long term contract and “life happens” – creating a potential need to access a large portion of your funds.
What is a Lifetime Income Annuity?
The lifetime income payments are still available the old fashioned way we discussed, called annuitization. In a Fixed Index Annuity, the insurance carrier may require the owner to hold the contract for at least one year, but often times up to five years or even the end of the surrender charge period, which can range anywhere from 5 – 15 years in length. But, the newer way we referenced earlier is the income rider. An income rider most times has an annual fee. The annual fee ranges anywhere from about 40bps to 150bps and is achieved by multiplying the annual charge times the income value (which we will cover more in depth later). For example, if the income rider charge is 100bps (or 1%), the initial premium is $100,000 and the Income Rollup Rate is 10% each year, it might look like this:
Year 1: 1% x $110,000 (Income Value after year 1) = $1,100 as an annual charge.
Year 2: 1% x $120,000 (Income Value after year 1) = $1,200 as an annual charge.
And so forth and so on, until the income rider is turned on (or cancelled – which most contracts allow in case you change your mind about your future needs). Once the rider is turned on and lifetime income begins, the rider fee amount is locked in for the duration of the insureds lifetime income. Each year, the rider fee amount is deducted from the account value. This rider fee percentage (typically 40bps t0 150bps) is locked in at the beginning of the contract for most every contract in the industry, but the specimen contract should be read to be aware of the stipulations. A good insurance agent will know these rules, so it is important to ask these questions when working with someone suggesting this product as part of your retirement plan. Most times the rollup period is 10 years long with some insurance companies offering to extend the rollup period for an additional 10 years for a total of 20 years. The second 10 years will provide the insurance company an opportunity to increase the annual income rider fee when you choose to extend the rollup period for the additional period. And while less common, there are some Fixed Index Annuities with income riders that allow the rollup period for the life of the contract, until turned on.
So let’s now discuss the various rollup rate options:
- A fixed or guaranteed rollup rate: this typically ranges from 5 – 10% a year and will either be simple or compounded interest.
- A fixed or guaranteed rollup rate combined with current contract year account value credits. The guaranteed rollup rate may vary from approximately 2 – 5%. In addition, they will add credits based on current account value earnings on top of the guaranteed rate. It is typically 100% up to 200% of the interest earned.
- A bonus: A bonus can be added initially to either of the options defined above, as well as just a variety of bonus credits. One carrier has a product that credits a 20% bonus to the income value day one, again at the beginning of year 3, then again at the beginning of year 6. They go further to say that if you hold off beginning the lifetime income stream until after the 10th year they will double the initial premium as an income value (only for the purpose of the lifetime income calculations; and is not a part of the account value)
While there may be some slightly different ways to credit interest to the income value, these are the three main ways. Now then; let’s look at the formula used to calculate your lifetime income. When you decide to turn on the income rider and begin your lifetime income, they will multiply the income value by the payout percentage, which is based on the insureds current age. For example, if the insured is age 60, the payout factor may range from 4% to 5% for a single life payment, depending on the guidelines written into the contract. For joint life option, the payout factor will typically be 50 – 100bps less. Keep in mind the payout factor will typically increase as you get older. The payout factors, as well as the rollup rates are guaranteed in the contract, providing you the ability to target a specific income for a specific age and confidence in your purchase. Let’s take a look at how one of these income riders might work.
Let’s say the insured is 60 years old at the time of purchase and $100,000 is placed into a Fixed Index Annuity with an income rider. Let’s also assume the insurance company offers a 10% simple interest rollup credit for ten years and at age 60 the payout factor is 4%. The following table gives an idea of how it would work (keep in mind these numbers in no way reflect an actual account value are for the purposes of Lifetime Income calculations only).
Even though features, such as compound or simple interest, bonuses, rollup periods and payout factors vary, the premise is mostly the same. Some of these income riders will also include additional features to increase your payment to assist with nursing home care. So with several moving parts, it is essential to have a trusted agent to help you navigate the minor to major differences so you can be assured you find the best solution for your goals.
“Show me and I’ll forget; teach me and I’ll remember; involve me and I’ll understand.”
Confucius
At Pacific Insurance Group, when we work with you and your family, this will always remain our constant goal. So please do not hesitate to contact us so we can help you discover whether this type of product is a fit for your needs.
Let Pacific Insurance Group help you pick out the right annuity.