Income Riders – What are they and how do they work?

One of the biggest concerns in retirement is simple, Will my income last as long as I do? There are a few ways to create guaranteed lifetime income. Two of the most common are:

• Single Premium Immediate Annuities (SPIA)
• Fixed annuities with an income rider.

We’ve covered SPIAs in another article. You can view it here. Let’s discuss how income riders work and help you decide if they fit for your situation.

What Is an Income Rider

As the name implies, an income rider is usually an optional feature attached to a fixed or variable annuity. In some cases, the rider is automatically included. They are commonly called Guaranteed Lifetime Withdrawal Benefits or GLWBs.

Its purpose is straightforward. It gives you the option to turn on a guaranteed lifetime income withdrawal either now or later.

A Simple Way to Understand It

When you add an income rider, your annuity starts tracking two values at the same time:

• 1. Your Account Value
  • This is your actual money.
    • It can grow based on the index strategy you choose.
    • It can be accessed (depending on the withdrawal provisions in your contract).
    • It’s reduced by income rider fees and withdrawals.
• 2. Your Income Account Value
  • This is a calculation used to determine your future income.
    • It grows with a roll-up rate and sometimes an upfront bonus
    • It is not money you can withdraw as a lump sum

Key Terms (Without the Jargon)

Here are some terms you should know when researching Income Riders.

• Income Account Value (IAV) – The value of your income account. It includes your premium plus any bonuses and roll ups. This is a calculation value, not real money you can withdraw. It’s used only to determine how much lifetime income you’ll receive.
  
• Income Bonus – This is an upfront percentage added to your premium for the IAV only. There are products that have bonuses that are credited to the Account Value, but many only credit to the IAV.
  
• Roll-Up – This is the interest rate that is added to your premium and your bonus, if any. It is usually only guaranteed for a specific time, i.e. – 10 years. The roll-up stops when income starts.
  
• Payout Rate – This is the percentage used to calculate your guaranteed lifetime income.
  
• Enhanced Payout Rate – This is the percentage used to calculate the income when disability occurs. Some income riders have this feature.
  
• Rider Fee – This is the fee for the income rider. It is calculated based on the IAV and subtracted from the Account Value.

When you start taking the lifetime income the insurance company uses the Income Account Value and applies the payout rate based on your age and sometimes how long you’ve held the annuity.

How the Income is Calculated

Mike, age 65 puts $100K into a Fixed Index Annuity with an Income Rider. He wants to turn on income in 5 years at age 70.

His rider includes:

• 10% bonus
• 7% roll-up rate.

With a 10% bonus, Mike’s starting IAV is $110,000. The IAV earns 7% per year.

• After 5 years his IAV is $154,281.
• At age 70. The payout rate is 6.50%.
• The guaranteed lifetime income is $10,028 per year.

I know I’m repeating myself, but I want this to be very clear. The Income Account Value is not available to cash out. It is not your Account Value, and in most cases it is not available as a death benefit. It is a phantom value that is ONLY used to calculate lifetime income.

When you open the annuity, two values are growing at the same time.

The IAV is only used to calculate the income. The AV will grow based on the index or fixed rate strategy chosen. Since the interest credited is linked to an index some years you may have an interest credit and some years you may not, but your AV will not go down due to market fluctuations. The Income Rider Fee will be deducted from the Account Value each year.

What Happens After You Turn Income On?

Once you start taking income you’ll receive guaranteed payments for life. Your Account Value

• continues to earn interest (based on your choices in the contract)
• pay rider fees
• is reduced by your withdrawals.

Your IAV essentially goes away. The rider fee is locked in at the value it was when you turned it on. If you decide to stop taking the income and then turn it back on, the income will remain the same as when you turned it on originally.

Even with modest returns, once income starts, withdrawals and rider fees will eventually reduce the account value to $0. But here’s the key: Your income continues for the rest of your life, even if the account value runs out.

For those of you who like to see the numbers, I’ve created a chart using Mike’s example showing how the AV and IAV work during the waiting period and after income turns on. You can see this here.

Withdrawals NOT Annuitization

One important difference between income riders and SPIAs is how the income is taxed An Income Rider is a withdrawal benefit. Because of this the payments are treated differently than a SPIA when it comes to taxation. All withdrawals from annuities, including the Income Rider withdrawals, are paid Last In/First Out (LIFO). This means that if you use after tax funds to purchase your annuity, when you turn on the income rider the initial payments will usually be interest, especially if you wait to turn on your income. Once the interest is paid out, the income will be principal (and not taxable) until there is additional interest credited to your Account Value. Once the Account Value is $0, the payment will be fully taxable. If you are under 59 1/2 when you take withdrawals, you may also be subject to a 10% IRS penalty .

Enhanced Income for Health Events

Some income riders include an additional feature that can increase your income if your health changes. It is usually called an Enhanced Withdrawal Benefit or Income Doubler.

This benefit will increase the guaranteed income, usually by double, in cases when you become disabled. The general rule used to determine if you qualify for the benefit is that you cannot complete 2 out of 6 Activities of Daily Living (ADL). The ADLs are

1. Bathing
2. Dressing
3. Toileting
4. Transferring (mobility)
5. Continence
6. Eating

Once verified by a physician, your income will double for up to 5 years or until the Account Value is $0, whichever comes first. Some will double even if the AV is $0.

If you are purchasing an income rider for this benefit, please be sure you understand when it will and will not pay. It’s important to understand this is not a replacement for long-term care insurance.

Is An Income Rider Right for Me?

When it comes to planning for lifetime income, it’s important to compare different options carefully. That’s why we quote both SPIAs and Income Riders when working with our clients.

An Income Rider has more flexibility than a SPIA. You can turn on income when you want and stop it down the road. You have an Account Value that continues to earn interest, and you can cash it out if you want. You don’t have these options with a SPIA.

When it comes down to it, what the bonus, roll up, or payout rate is doesn’t matter. What matters is the guaranteed income number and that the product works for your needs.

Want Help Sorting Through Your Options?

If you’re trying to decide whether an income rider or another strategy makes the most sense for your situation, we’re happy to walk through it with you. Just click on the “Schedule a Call” button above. No pressure. Just clear, straightforward guidance so you can make the right decision for your retirement.

This is general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Product suitability must be independently determined for each individual investor.

Riders are available for an additional fee – some riders may not be available in all States.

A fixed annuity is intended for retirement or other long-term needs. It is intended for a person who has sufficient cash or other liquid assets for living expenses and other unexpected emergencies, such as medical expenses.

All guarantees are based on the claims-paying ability and financial strength of the issuing insurance company.

Examples are hypothetical and for illustrative purposes only. Actual results will vary and may be more or less favorable than illustrated.