Hybrid Annuity Income Riders - Secure Retirement
In video seven below from a seven part video series on “Which Annuity is The Best Annuity” Dick and Eric tackle the subject of the new generation of income riders that have helped hybrid annuities become what they are. These innovative new hybrid annuity income riders secure future income on a higher guaranteed basis than what is the potential outcome if money is left at risk in the market or invested in low earning CDs or savings accounts. In addition they offer a pension style income that cannot be outlived and one more thing did I mention — any money that the annuity owner does not spend goes to heirs at death – what other pension does that! There are also some that even go a step further and help with long-term care or home health care needs as well without sacrificing needed recurring retirement income. Enjoy this video on hybrid annuity income riders:
Securing Your Retirement With a Hybrid Annuity & Income Rider
Annuity Income Riders & Living Benefit Riders
Living benefit riders are another optional benefit that may be chosen on many annuity contracts. These riders must be requested at the time an annuity holder begins an annuity, as it is highly unusual to be allowed to add a living benefit rider to an existing annuity.
The first income riders were introduced on variable annuities at the turn of the twenty-first century and were created to protect the annuities ability to generate future income even with investment risk to principal. This is accomplished by guaranteeing the minimum level of income that can exceed what is payable from the annuity investment account value and is paid at a potentially higher income rate regardless of weak growth or losses in the variable annuity investment account value. These types of riders became competitively available a few years afterwards on fixed, as well as fixed index or hybrid annuities, so that not only the income but also the principal could be contractually guaranteed.
These riders can provide annuity holders with a guaranteed income for life, and––unlike the immediate annuity––without the need to give up access to the principal in the annuities cash value.
A living benefit rider on an annuity can help to reduce the risk of substantial loss with a variable annuity by providing guaranteed payouts for the risk-averse variable annuity holder. Although these riders require additional fees, they will provide a secure guarantee to protect the variable annuity income against declines in the market, in addition to providing a guaranteed minimum income that will not fluctuate.
With income riders, the income value is totally separate from the annuity’s accumulation value. Normally with variable annuities, this income value will grow at a 5 percent to 6 percent compounding rate of interest. Hybrid or fixed index annuities typically have higher income account growth compounded at 6 percent to 8 percent. Then, when the annuity holder starts taking lifetime withdrawals from the account, there is a payout percentage factor based on the owner’s age that is applied to the income value in order to determine the amount of the guaranteed-for-life income withdrawals. For example; a seventy year old retiree may be allowed to take a 6 percent draw on his or her income account value of say one million dollars, which equates to sixty thousand dollars of income annually as long as he or she is alive. This is true even if his or her cash value account has only seven hundred thousand dollars accumulated from low interest earnings and runs out in twelve years or so with continued poor earnings.
If the cash accumulation value is higher than the income account value when the annuity holder starts receiving the income from the annuity, then the accumulation value will be used in the calculation of the life payout instead of the income account value. Once the guaranteed withdrawal payout percentage amount is determined based on age, the annuity holder may then begin to withdraw that amount of income from the annuity each year on a monthly, quarterly, semiannual, or annual basis throughout the remainder of his or her life.
When the annuity holder begins receiving this payout, he or she will typically have several guarantees. Two of these include:
- The additional crediting of interest to the annuity’s cash accumulation value, along with continued access to the cash value when needed from the remaining cash accumulation value. (Warning; these excess withdrawals can substantially lower guaranteed income being paid out for life)
- Even though the annual guaranteed withdrawals from the annuity may deplete the cash accumulation account value over time, the issuing insurance company must continue to make the guaranteed income payments as long as the annuity holder lives, including to the spouse, if a joint payee is selected.
How Annuity Income Riders Work
How It Is Used
This is the cash basis for most annuity benefit calculations, including the value to be paid at death, surrender, or maturity.
This is the cash account value.
It has one primary purpose: it is the value or formula that is used to determine the lifetime amount of each payment that may be minimally guaranteed by the annuity. There is no cash account value here only an income stream.
How It Grows
Interest plus any bonus is applied to an annuity allocation dollar amount using a choice of fixed or market index interest strategies for growth.
Interest plus any bonus that was applied to the funds allocated to the annuity then income account growth is guaranteed at a contractual percentage while in deferral.
Types of Living Benefit Riders
There are several types of living benefit riders, and they all differ in terms of the benefits that they can provide. Some of these riders include:
Guaranteed Minimum Income Benefit Rider
This living benefit rider guarantees a minimum future payout, regardless of how the market performs. However, this rider will typically require that the accumulation phase of the annuity be kept in force for a specified time period before the rider will take effect.
This rider is designed to provide the annuity holder with a base amount of lifetime income when he or she retires, regardless of how the interest or investments inside of the account have performed.
It will guarantee that when the annuity owner is eligible to annuitize the contract––either for life, life plus a certain time period, or for the lives of two individuals––then the annuity income payments will be based on the greater of either the amount that was contributed plus a predetermined interest rate or the maximum anniversary balance of the cash value account based on interest applied or underlying investment earnings prior to annuitization.
In order to receive this benefit, the annuity holder must annuitize the account. In addition, there is normally a required holding period of ten years before this rider may be exercised.
Guaranteed Minimum Accumulation Benefit Rider
This living benefit rider will ensure that the annuity holder is able to retain the value of the contributions plus a minimum growth, regardless of the investment losses or lower earnings. This benefit will also require a specified period of time to determine if the annuity’s investments or interest is lower than the guarantee; the annuity issuer will then make up the difference in income as required.
In other words, the guaranteed minimum accumulation benefit rider will guarantee that an annuity owner’s income account value will be at least equal to a certain minimum percentage of the amount that was contributed after a specified number of years, regardless of the actual performance of the investments. Typically, the holding period is somewhere between seven and ten years.
Guaranteed Minimum Withdrawal Benefit Rider
This living benefit rider option will guarantee a return of the contribution amount through a series of fixed annual withdrawals. These annual withdrawals are guaranteed until the annuity holder’s principal is returned, regardless of the investment performance or interest earnings.
Therefore, this rider guarantees that a certain percentage of the amount that is contributed can be withdrawn annually until the entire amount is completely recovered, regardless of market performance. It should be noted that in this case, reducing the amount of the withdrawal in one year will not allow the annuitant to increase withdrawals in subsequent years.
However, if the annuity owner decides to defer the withdrawals and the value of the annuity account grows, then the amount of subsequent withdrawals that are allowed could be larger.
If the investments in the annuity account perform well, then there will be an excess amount in the account at the end of the withdrawal period. However, if the underlying investments perform poorly and the value of the annuity account is depleted before the end of the withdrawal period, then the annuity owner can still continue making withdrawals until the full amount of the original contribution is recovered.
In addition, should the annuity owner decide to terminate the account prior to the end of the withdrawal time period, he or she may then receive the amount of the cash surrender value in the annuity which could be considerably less than the systematic and guaranteed withdrawals.
Guaranteed Lifetime Withdrawal Benefit (GLWB)
Another more recent type of guaranteed minimum withdrawal benefit that was introduced into the annuity world is the guaranteed lifetime withdrawal benefit. Here, it is guaranteed that a certain percentage of the account value––usually between 4 and 8 percent, depending upon the youngest of the annuitant’s or spouse’s age if a joint income payout is selected––may be withdrawn each year for as long as the annuity holder or spouse, if joint, lives. This percentage varies, depending upon the annuitant’s age when he or she begins taking withdrawals.
While in deferral, this type of guaranteed lifetime withdrawal benefit can compound at 6 to 8 percent or more on a guaranteed basis. This is not to be confused with the actual annuity cash value account. This account has no real cash in it. It is simply an accounting ledger to determine minimum income owed at the present or some future date.
Typically, deferred annuities will allow the owner to surrender the contract during the accumulation phase and receive a cash payment. The amount that is received is called the cash value or cash surrender value. This sum is equal to the amount of contributions made to the annuity plus any earnings minus any prior withdrawals or charges.
The annuity owner may take a partial withdrawal, if he or she cannot fully surrender the annuity during the accumulation phase without a penalty. However, there may be some surrender penalties incurred if more than the penalty-free portion is withdrawn, which is usually about 10 percent annually, as well as federal income tax due on any of the gain.
The amount that is paid to the annuity owner upon surrender may be subject to a surrender penalty. These penalties typically range from 5 to 12 percent. Some deferred annuities will impose a surrender change only for an initial period of time after the annuity contract is initiated, while other annuities begin a new surrender charge period for each individual contribution that is made into the annuity. In most cases, however, these surrender charges will typically decline to zero after a specified period of time has elapsed.
If the annuity owner elects to take a partial surrender, he or she will generally have the option to do so as a pre-scheduled series of payments under a systematic withdrawal plan. Many annuities will allow annual withdrawals of 10 percent or more of the annuity accounts cash value that is free of surrender penalty charges. Yet, in any case, federal or state tax may apply to a portion or the entire withdrawal amount and, when younger than fifty-nine and a half, the tax code may impose a 10 percent penalty for any early withdrawal.
Long-Term Care Protection
Some annuities offer features that are designed to address long-term care needs, such as increased income payouts of two to three times the actual cash account value for long-term care needs. In fact, many annuity accounts also allow their owners to withdraw funds from the account for these needs without incurring any surrender charge or penalty. For example, surrender charges might be waived if the annuity owner has been confined to a nursing home for a minimum time period or if he or she is suffering a terminal type of illness.
Additional access to penalty-free funds could even be available for home health care, care-giving, consultation services, or certain types of discounted long-term care services from a specific group of providers.
When Are Living Benefits Riders Right?
To truly determine if a living benefit rider is best for a retirement plan, it is important to understand exactly what the purpose of the annuity will be. For example, certain questions should be answered, such as:
- What is the purpose for the funds?
- Does the annuity income stream need to start soon or at some later time?
- How much income will be needed?
- Is it important to leave money to heirs?
- Is long-term care spend-down a concern?
- How much control should be maintained over the money?
- Is outliving income a concern?
Once the answers to these questions about a retiree’s specific situation is determined, there is some information that must be gathered about the income rider being considered. Some of the important details include:
What is the roll-up rate? Many annuity income benefit riders offer a guaranteed rate of growth, or roll-up, of between 5 and 10 percent. This roll-up rate is essentially the guaranteed annual rate at which the income base will grow. Therefore, if an annuity with a contribution amount of $100,000 offers a ten-year income rider at 8 percent, then the income base would actually be $215,892 just prior to the payout period. Then, at the end of the ten years, the income stream from the annuity would be based on an annual percentage of the income base determined by the annuitant’s or joint payee’s age at the time that the payout phase began.
Is the interest being credited compound or simple? When comparing different types of annuity income riders, it is important to truly understand the type of interest being credited. For example, a 10 percent roll-up rate is typically going to be based on simple interest, and 10 percent simple interest is the same as 7.2 percent compounded for ten years after that the compounded rate grows much faster and larger.
How many years can the income base accumulate? There are many income riders that will not allow the income base to accumulate beyond ten years before the annuity holder must start taking the income payout. However, there are a select few that allow much longer accumulation periods.
What are the fees now, and can those fees increase over time? Many annuity income riders will have fees of between .40 percent and .95 percent. In addition, there are some that may be allowed to increase the fees, after a specified number of years, up to 1.5 percent or more.
What account are the fees assessed to? It is important to understand whether any fees are being deducted from the accumulation value or the income base because there may be times when the accumulation value does not grow. In this case, it would be better to have any fees deducted from the accumulation value.
When are fees deducted? Typically, fees will be deducted on a monthly basis. However, some annuity issuers will deduct them on an annual basis.
Will the income base on the annuity continue accumulating if the annuity holder takes a free partial withdrawal or a required minimum distribution from the base contract? This information is important to know because with some income riders the income base account will stop the guaranteed roll-up percentage forever if a partial withdrawal is taken.
Are there any additional benefits triggered for long-term care or the loss of function in doing basic daily activities? Sometimes an annuity will offer to increase the income benefit in these types of cases.
Can the annuity holder remove the income benefit rider from the annuity? Some income benefit riders are revocable and others are not.
Is it possible to get more than just the accumulation value upon death? With most income riders, when the annuitant takes income from the annuity, it will deplete the accumulation. When the annuity holder passes away, then his or her heirs will not receive the income base. Instead, they will receive whatever amount is left of the accumulation account value; if the annuitant lives a long life, there may not be anything left. There are a few annuities that allow the income base, if it is greater than the accumulation account, to be paid out to heirs over a specified period of time.
Annuity Guys Video Transcript:
Dick: Eric, in our last session we talked about hybrid annuities, and how there are so many different annuities that have certain aspects that are very good and that we’ve kind of combined those together to make what’s called a hybrid annuity. I thought it would be good in this session; we could discuss the riders that make a hybrid annuity so unique.
Eric: Well, that’s exactly what a hybrid annuity is. It’s basically a fixed indexed annuity. When you start adding riders to it and what the riders do is what makes it a hybrid, because as we talked before a fixed indexed annuity has the ability to become basically, if through annuitization, a lifetime income.
Dick: Right, pension style.
Eric: Pension style. However, most people usually think of that fixed annuity as more of an accumulation vehicle, rather than true income vehicle. Well, by adding some of these income riders it becomes a much more efficient retirement vehicle.
Dick: Right. Well you mentioned annuitization, now an income rider is much different than annuitization. Let’s tackle that just for a minute. Annuitization is just what we talked about with an immediate annuity. That’s where it becomes a pension style income that lasts you for the rest of your life, but you give your lump sum. Now an income rider is much different.
Eric: Right. When you’re looking at using an income rider, you’re looking at a contractual guarantee.
Dick: For life.
Eric: Exactly, when you’re looking at these hybrid annuities a contractual lifetime income guarantee that you’re basically, paying for typically. Some of them are free; some of them are included in part of the vehicle, but usually you’re paying for the income rider. What that does is it gives you, at the point where you activate the rider and turn it on you get an income for life, for whatever age you’re at for the rest of your life.
Dick: But what happens to my lump sum?
Eric: Your lump sum maintains—you still have majority control over it, so whatever is sitting out there you can still get into now.
Dick: So when we talk about majority control, what we’re talking about when we say majority control is that you could get to the majority of the money that you had in the policy, if you had a need for it and there are surrender charges and that type of thing in annuities, and so when…
Eric: It is possible that it could be out of surrender. So it is possible for you to access 100%. However, we always indicate majority control, because even in the worst case for most of these annuities, if you got a big bonus with one of these hybrid annuity riders, there’s possible surrender charges in that first year and they’re between 15% and 20%, which sounds like a huge number.
Dick: When you subtract that bonus out, you’re down to maybe 10%.
Eric: Right, and that’s more of a typical…
Dick: They want their bonus back, if they give you a bonus.
Eric: Right, and that’s more typical and you think about 10% that sounds like a huge, hefty surrender fee, but how many times have we been in the equities market, and we’ve seen 10% drop in a given month or two, so it equates. I don’t want to equate it to the equities market, because that’s not what we’re looking to do here, but you still have access, if you had to go in and get it, usually in the upwards of 90% of your money, you have access to it, just even day one.
Dick: However, let’s go back to the lump sum if you annuitize or do an immediate annuity that lump sum is gone. There’s no way to get back to it. No way to access it. You have no majority control of any type, and if you pass early it is possible that none of that will go on to your heirs. If you set it up in such a way that a certain percentage could go on to your heirs, of the remaining payments or what we call refund of premium, but that always reduces the amount that you can receive in lifetime income. And the difference being, I’m kind of getting carried away here on annuitization. However, if you have an income rider and you should pass early, that lump sum that you have not used in its entirety will go onto your heirs. So that would include a bonus, it would include the full account value with no surrender charges. So it’s kind of like having your cake and eat it too because you can have an income that lasts as long as you live, and yet you have not given up your lump sum.
Eric: This is probably a good time to start addressing some of these riders and how they come into play. Because there are some, the pros and cons to everything that you look at, but the biggest thing with these income riders is they usually offer a guarantee, while the annuities in deferral of a higher than average, either return. Now the big caveat here is usually that guarantee is only on the amount of money that you can use for income. So, it’s not in your cash account.
Dick: You can’t get it all out at once.
Eric: It’s not your walking away account, so if you had to leave and take all your money that’s not part of what that higher than average guarantee is going to be applied to.
Dick: So when we talk about this account let’s make this more clear. You actually have two accounts. You have an account where your money goes into we’ll call that the cash account or the cash accumulation account. Then you have an additional account that is actually a mirrored account, it reflects what went into your account originally, that would be what’s considered your premium and any bonus that was added. That’s all reflected in the income account, and yet there’s really not any money so to speak, in the income account, but it is a ledger account that will continue to grow with the contractual guarantee. So, let’s just say that the economy isn’t that good and the cash account, the cash accumulation account, is maybe only growing at 2.0% or 3.0%. Well, that’s not going to be enough to retire on. That’s not going to give you the retirement income that you need at some future date, you know five, ten, fifteen years from now. However, if we have this income account that is guaranteed to compound at 7.0-8.0% perhaps and this is reality…
Eric: Right, right now 8.0% is the typical for the kind of the top-end income riders. You’re looking at an 8.0% deferral, so you know that over the course of nine years, it’s going to double that account value.
Dick: Right. So let’s just say that we’ve put in $300,000, okay? So $300,000 in our cash account, maybe because it’s only grown at 2.0% to 4.0% that cash account may only be up to $400,000-450,000. However in that same nine year period, we might be looking at somewhere in the $6-700,000 range for our income account.
Eric: And what’s nice is its predictability, so when you’re starting to plan a retirement plan knowing that that dollar amount is guaranteed, because that compounding number is guaranteed for income for life, and that’s where we look at using these as one of the cornerstones usually, on top of Social Security for retirement planning. Because you have a predictable income number, you know exactly what that is and that gives people peace of mind, and so when you know you can have in five or ten years we can tell you exactly that compounding number will generate.
Dick: Okay, so now we’ve got an account that reaches a certain size, and let’s just say that this income account has reached, let’s just say it doubled, so we have $600,000 now that we can draw from. How much can we draw out of that account guaranteed for life, Eric?
Eric: And this is where the other pieces come into play. They’re all, most of these annuities are based off of withdrawal, based off of your age, and then the other caveat is if you’re going to have a spouse joint lifetime income. So usually, you’re looking at your age and it’s a percentage based off that age, so if you’re age 60, a lot of these annuities start at 4.0%. You’ll look at a 4.0% for a joint lifetime.
Dick: Or actually age 60 on a single, typically it will start around 5.0%, but when you’re speaking joint, you’re going to drop about a .50% and sometimes 1.0%.
Eric: Depends on the annuity.
Dick: Yes, so then you’re in 4.0% or 4.50%.
Eric: And this is where that really working with different products and looking at different options, based off your individual situation, really comes into play because while one person may decide to retire at 65, and another one wants to turn this on and start getting that retirement income at 66, some of these annuities have significant differences of payout based off that age.
Dick: Yes, they do.
Eric: And so looking at those things and knowing to run those numbers across.
Dick: There are some companies that will increase your payout each year that you defer and some companies make you wait for 10 years, before they will actually increase the payout. Big, big difference when we run those numbers. There’s also the aspect of compounding. Some of the contractual guarantees do not compound and so you’ll be looking at simple interest, and there’s a big difference between simple interest and compounding interest on that income account and the big difference in the payouts. These are all concerns that will make a big difference.
Eric: And the nice thing is you can run these numbers side by side, and because of the predictability of it, you can know in a five or ten year scenario, what’s going to work out better for your situation, and that’s what you want to do, you want to look at those pieces side by side.
Dick: And one of the things that we look to do Eric is when we’re working with our clients is structure for inflation, big, big difference in these annuities and the way that they can be structured. Now obviously, if you can defer for a good length of time that helps to produce a good inflation hedge, because you’re looking at say 8.0% compounding, and you know that this account is going to reach a certain level by a certain date. However, you may have to turn that income on at an earlier date, and so the compounding affect won’t be as great. However, you need to know that you’ve got some type of inflation hedge built-in and some of these products work better than others.
Eric: Right, there are some products that actually increase your payout each year with gains in the index, very unique.
Dick: Very few do that.
Eric: Yeah, not a whole lot out there that do that, the other way that you tackle that is by tiering or laddering. You actually use annuities spread out over a period that you’re going to turn on at different times of your life to kind of combat inflation. Those are the things that, when you’re looking at putting together, you don’t necessarily want to always put all your eggs in one basket or one type of annuity, because different annuities and how it’s structured, can have a big impact on your retirement income, in the future of what your income will be in the future.
Dick: And really Eric, we’ve just scratched the surface on these annuity riders.
Eric: We haven’t even talked about home health care or health care doublers.
Dick: Right, exactly. Long-term care comes on these. One thing that I would like to recommend that our site visitors do is consider going to our premium section where they can actually look at some case studies and get a lot more in-depth information.
Eric: Well, if you’re like me it always helps to have an example, and when you have an example of something to consider, how somebody else did it before you and we’ve got a couple of those pieces out on the website.
Dick: Right. Well, one here is Bill and Cindy, and then I think I have to back this up. The other one is Tim and Laura. They both have very different scenarios. There are some similarities, but very different scenarios objectives that they’re trying to accomplish, and yet they were both able to use a hybrid annuity. And I think folks, if you’re like me it really helps to look at somebody else’s situation and see how they did something, and then it helps me to put myself in that same understanding, of what I might do in my unique situation.
Eric: To find the case studies, they’re in our premium section, as Dick said. If you’re on the site right now, if you look up at the toolbar and you see the annuity rates tab in the menu bar there, if you click on that, that’ll take you to our essential annuity tools page. On there, there’s a form that you can fill out to get access to the premium section.
Dick: One other thing I’d like to mention here that you’ll get when you go to the premium section, now we can’t email this to you, you can’t send paperback books through the email. But what we can do is send you our e-book version, which really has everything in it. It’s a great reference manual. We’ll be glad to send that to you.
Eric: You get that access on the essential tool pages as well, so it’s there for immediate download after you fill out the form.
Dick: Well, and there’s rates on our premium section, so you can look at thousands of current rates up to date, ratings features on each of the annuities. So that’s something that you’re going to want to consider doing, as you’re more serious about moving forward and understanding, making good decisions on an annuity, and we don’t want you to hesitate to give us a call if you have a question. We won’t necessarily be the ones that will implement an annuity for you or anything of that nature, but we do want to be a reliable resource for you and assist you, whether it’s helping you find an advisor in your local area or just getting some good information that you need. That’s what we’re here for.
Eric: Have a great day.
Dick: I think we covered it all. Thanks, folks.