Learn Whether a Traditional Annuity or an Income Rider is Best for You

Retirees and near-retirees are clamoring for more guaranteed lifetime income. But to optimize that income, they first have to sort through the different options and some heavy-handed marketing efforts.

There are two basic paths to consider for guaranteed lifetime income.

One path is traditional annuities.

When you want income to start within the next 12 months and continue for the rest of your life, a single-premium immediate annuity (SPIA) usually is the best choice. You deposit a lump sum with an insurer, and the insurer tells you how much income it will pay you each month for the rest of your life.

You can modify the SPIA. Some people want at least part of their deposit paid to beneficiaries if they don’t live to at least life expectancy. Others want the income to increase at a fixed rate each year. The annuity can be modified to achieve those goals.

There are other options available. See our January 2023 issue for more details.

But keep in mind that each option reduces the monthly income below what the plain vanilla SPIA would pay.

When you don’t need the income to start for a few years, consider a deferred income annuity (DIA), also known as a longevity annuity.

In a DIA, you deposit a lump sum with an insurer and decide the date in the future you want income payments to begin. The insurer tells you today the amount of income it will begin paying you on that date and promises to continue paying that amount for the rest of your life.

These choices for guaranteed lifetime income are clean, simple and low cost.

The other path to consider is income riders.

An income rider isn’t a stand-alone financial product. It is a contract term attached to another financial product, usually a fixed indexed annuity (also known as an indexed annuity) or a variable annuity. Most income riders sold today are part of fixed indexed annuities (FIAs).

FIAs are more complicated than traditional annuities, and there are a lot of variations.

In a FIA, you deposit a lump sum with an insurer. The insurer usually promises to credit your account with a minimum interest rate each year.

There’s also the potential for the account to earn a higher interest rate. The account is tied to a market index or an index that’s a blend of several indexes. Either you select the index from choices offered by the insurer, or the insurer selects the index.

When the index performs well in a year, your FIA account can be credited with additional interest. But the account rarely is credited with the full return of the index. There’s a cap rate, the maximum interest rate that will be credited.

There’s also a participation rate. If the participation rate is 100%, your account is credited with 100% of the index’s return (until the cap rate is applied). But most FIAs have a participation rate less than 100%. If the participation rate is 50% and the index returns 10% for the year, your account earns no more than 5%.

Additional fees might be subtracted from the index return, and there are other limits or nuances to the interest calculation. We can’t go into all those details now. See the longer discussion in the September 2022 issue of Retirement Watch.

If you want guaranteed lifetime income, you can buy an FIA and have an income rider added.

The income rider says that at some point in the future, if you choose, the insurer will begin paying you a minimum amount annually for life. You aren’t required to begin receiving the income. You can continue to let the FIA earn annual interest, or you can close the annuity and withdraw your balance.

Most income riders let you turn the income on and off. You can begin receiving income but after a few years tell the insurer to stop paying income for a while. The account goes back to earning interest. Later, you can have income payments resume.

An income rider carries an additional fee, usually around 1% of the account balance, that continues after the income payments begin.

An income rider is only for someone who wants guaranteed lifetime income to begin a few years in the future. If you want income to begin within the next year, a SPIA usually is the way to go.

Usually, you must wait at least one year before income can begin under an income rider, and for the income rider to be a good deal you probably want to let the FIA earn and compound interest for eight years or longer, according to annuity expert Stan Haithcock.

One pitch for income riders is the income has a guaranteed floor but could increase over time if the index tied to the annuity does well. Don’t give much weight to the potential for the income to increase.

Some presentations will use back-tested or historic numbers to show how much the income would have increased if you bought the FIA and rider 10 years earlier. But that increase is far from guaranteed. As the small print says, past performance is no indicator or guarantee of future performance. Some states now prohibit such back-tested performance numbers in annuity presentations.

Also, some income riders that depend on back-tested numbers use unique indexes constructed for the annuity. Often these indexes weren’t available 10 years earlier.

In most FIAs, the insurer can change the index tied to the FIA at any time.

If the income from the rider has a realistic chance of increasing over time, that usually means the insurer set the initial income payment lower than would be paid by a SPIA or a rider with a lower probability of income rising.

When there’s a real potential for the income to increase, you need to do long-term projections and determine how long it would take for the income to rise to the level a SPIA or DIA pays. Also consider how well the index must perform for the income to increase.

My point is that you shouldn’t buy a FIA or income rider because of the potential for the income to increase, especially when the increase relies on a duplication of exceptional past performance of particular indexes.

A FIA generally will pay interest like a CD or multi-year guaranteed annuity (MYGA). Your principal is protected, and you earn a good yield while waiting for the income to begin. A FIA with an income rider can be a good alternative to a DIA or to keeping your money in safe investments before buying a SPIA in a few years.

But you need to compare all the options. Look at all the income riders available in the market. Be wary of a presentation that involves only one policy and doesn’t compare it to others. You also need to compare an income rider with SPIAs and DIAs.

I always recommend that you use an insurance agent who deals with a range of insurance companies and isn’t tied to one company or a small number of insurers.

Stan Haithcock, also known as Stan the Annuity Man, is a good source. At his website, (www.stantheannuityman.com), you can review free and without obligation all the options in SPIAs, DIAs and income riders. You can also book a free appointment to talk with Stan about your situation.

Another good source is Todd Phillips, of Phillips Financial Services. He can be reached at 1-888-892-1102. Todd studies the breadth of the FIA and income rider market. He’ll learn your situation and recommend an appropriate solution.

Guaranteed lifetime income is essential for most retirees. But all guaranteed lifetime income sources aren’t equal. Since the income will continue each month for the rest of your life, it’s well worth your time to shop carefully before deciding which source or sources to put in your plan.