What is an Annuity Income Rider?
The Annuity Man
The most popular annuity benefit available today is what the annuity industry calls an Income Rider. You can’t buy one as a stand alone product, but only as an attachment you choose to add to a deferred annuity at the time of application. Typically, income riders are attached to Variable Annuities (VAs) and Fixed Index Annuities (FIAs)….and that’s where some of the bad sales practices happen and why you need to know exactly what you are buying.
Draw A Line
If you visually draw a line down a blank sheet of paper, the left hand side is the accumulation value or what I call the "walk-away" amount. With Variable Annuities (VAs), that would be the potential growth from the separate accounts (aka: mutual funds). With Fixed Index Annuities (FIAs), the accumulation value would be the potential index call option returns.
The right hand side of the ledger is the Income Rider benefit amount. It’s a totally separate calculation from the accumulation value, and is “monopoly money” and a "phantom account." What I mean by that is the income rider value can’t be cashed in, or interest peeled off, or even transferred to another annuity. That income rider value can ONLY be used to calculate your first lifetime income payment. That’s the primary function of an income rider, which can be a good thing if you are planning for a future pension type income.
Once you attach an income rider to a deferred FIA or VA policy, the income rider value will typically be higher than the accumulation value. It's designed to work that way in order for you to keep the policy to access that higher rider benefit amount. It's a subtle "policy handcuff" because income rider values can't be transferred to another annuity. Only the accumulation (i.e. real money/walk away) value can transfer.
Not Real Yield
Unfortunately, too many agents do not explain the details of how riders actually work. I get way too many calls where people claim they own a “7% annuity” or “8% annuity.” No you don’t! What you own is an income rider…with that high “Jimmy Carter percentage” being a phantom account or monopoly money that can only be used to calculate your first payment. Those income rider percentages are NOT yield! There are no geniuses at annuity companies that have figured out how to take a low Treasury rate and turn it into "Jimmy Carter yield." However, many agents will unfortunately allow you to believe that it is the case just to get the sale.
It’s very important to know that Income Rider lifetime income payments are primarily based on your life expectancy at the time you start the payments. Interest rates play a secondary role. In addition, the income stream is a combination of return of principal plus interest, so your account is being drawn down with each income payment. The good news is that if your account goes to zero, the annuity company is still on the hook to pay regardless of how long you live. That lifetime income guarantee is the unique benefit proposition that only annuities can offer.
Guarantees With Full Control
When compared to Deferred Income Annuities (DIAs) for "Income Later" guarantees, Income Riders allow you to retain full control of the asset even though the lifetime income stream transfer of risk is in place. In other words, you don't have to turn on the income stream as initially planned and you can change the start date after the policy is issued. Just remember, like Social Security, the older you are the higher the payments because your life expectancy is less. The younger you are the lower the payments because your life expectancy is more. It's that simple.
If you need a contractually guaranteed income stream, you either need “Income Now” or “Income Later.” Income Riders are a good solution for Income Later, and all carrier income riders should be quoted for the highest contractual guarantee available for your specific situation.