Category: Fixed Index Annuities

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Annuities Fixed Index Annuities Retirement Income Planning

Indexing Strategies to Eliminate Stock Market Risk

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This article was originally published in, and has been reprinted with permission from, Retirement Daily.

It’s no secret that I’m a huge fan of fixed annuities as part of a retirement income plan. The purpose of including fixed annuities in a retirement income plan is to reduce the risk of your investment portfolio. Two features of fixed annuities that have traditionally made them a preferred investment choice when compared to similar-duration CDs are higher interest rates and tax-deferred growth.

There are two types of fixed annuities that can be used to reduce investment portfolio risk:  fixed income annuities and fixed index annuities. This article will discuss how fixed index annuities can be used to reduce stock market risk.

What is a Fixed Index Annuity?

A fixed index annuity, or FIA, is a fixed annuity that offers a minimum guaranteed interest rate and potential for higher earnings than traditional fixed annuities based on the performance of one or more stock market indexes. FIAs can include lifetime income either with a minimum guaranteed withdrawal benefit (“MGWB”) or an optional income rider. Issue ages for most FIAs are 0 to 80 or 85.

There are two types of FIAs – single premium and flexible premium. A single premium FIA is a one-time investment whereas a flexible premium FIA allows for ongoing additions. Some insurance carriers place annual limits on the amount of premiums that can be added to their flexible premium FIAs.

When you purchase a FIA, you’re given the opportunity to allocate your initial premium between a fixed account and one or more indexing strategies. You can typically change your allocation during a 30-day window prior to each contract anniversary. The fixed account pays a fixed rate of return that currently ranges between 1% and 2%, depending upon the FIA.

Indexing strategies earn interest based on the performance of a defined stock market index, with the Standard & Poor’s 500 Index being the most popular offering. The measuring period for most indexing strategies is one year, however, two-year strategies are also available.

Fixed index annuities are subject to a declining surrender charge schedule that’s standard in all deferred annuities and is generally five to ten years. FIAs are meant to be held for the long term. Surrender charges help insurance carriers invest in longer-term bonds with higher yields and to recover initial fixed costs for setting up the contract. They also help actuaries price their deferred annuity products efficiently.

The majority of FIAs allow free withdrawals of up to 10% of the contract value or the initial premium beginning in the first or second year. Surrender charges apply only to excess withdrawals.

Losses are Eliminated and Positive Returns are Limited with a Fixed Index Annuity

Unlike a direct investment in an index where you participate in gains as well as losses, there are two basic differences when you allocate funds to an indexing strategy within a FIA:

  • If the index’s return is negative, no loss is posted to your account.
  • If the index’s return is positive, interest is credited to your account subject to a cap.

With a FIA, you don’t participate in losses. This is sometimes referred to as the “power of zero.” You also don’t participate in gains to the extent that the performance of a particular indexing strategy exceeds that of a defined cap.

FIA Indexing Strategy Examples

I will illustrate how FIA interest crediting works with some examples. Let’s assume that you invest $100,000 in a FIA and one of the indexing strategies that you choose is the S&P 500 one-year point-to-point strategy with a cap of 4%. Here are three different scenarios that occur during the first three contract years:

Year #1 – Return = 3%
Since the return is positive and it’s less than the cap of 4%, you’re credited with 3%, or $3,000, increasing your FIA account value to $103,000.

Year #2 – Return = 9%
Once again the return is positive, however, it exceeds the cap of 4%, therefore, you’re credited with 4%, or $4,120, increasing your FIA account value to $107,120. Although this is $5,150 less than the value of $112,270 through a direct investment in the S&P 500 Index, this needs to be balanced against the potential for loss.

Year #3 – Return = -12%
Since the return is negative, no interest is credited and you maintained your FIA account value at $107,120. Had you invested directly in the S&P 500 index instead of using a FIA indexing strategy, you would have realized a loss of $13,472, reducing your investment value to $98,798.

Gains are Retained with a Fixed Index Annuity

Unlike other types of investments, FIAs are unaffected by stock market declines. Although gains from increases in indexing strategies are limited by cap rates, they’re locked in.

The ability to shelter gains from subsequent losses isn’t available with most other types of equity investments. This benefit can be especially important for retired individuals who don’t have a long-time horizon to recover from sizable stock market losses.

The best way to illustrate this is with a multi-year example comparing an investment in the S&P 500 Index with a fixed index annuity S&P 500 indexing strategy for the duration of retirement using the following five assumptions:

  • Investment of $1 million at age 65
  • Annual withdrawals of $50,000 from age 65 to 90
  • Annual rates of return per the “Return” column
  • S&P 500 one-year point-to-point strategy with a cap of 4% and 7-year declining surrender charge schedule
  • Free annual withdrawals of 10% of the contract value in the first 7 years

There’s “good news, bad news” for the S&P 500 Index investment. The good news is that it participates in 100% of the positive year returns. This includes nine years when returns are 10% or greater and 20 out of 21 years when the returns exceed the FIA S&P 500 indexing strategy annual cap of 4%.

The bad news for the S&P 500 Index investment is that it participates in 100% of the negative year returns. While there are only five negative return years, three of which are single-digit, the first three years are all negative returns:  18%, 12%, and 3%, respectively. This results in a decrease in value from $1 million at age 65 to $574,000 at age 67. After a one-year uptick to $608,000, the value of the S&P 500 Index declines until it reaches $0 at age 88 after a final withdrawal of $14,000.

The fixed index annuity S&P 500 indexing strategy is the winner. Although annual returns are limited to 4%, which is less than the S&P 500 index returns in 20 out of 21 positive return years, interest crediting of 0% in the five negative S&P 500 years preserves the FIA S&P 500 indexing strategy value for the duration of retirement without reduction for losses.

There’s a total net increase in value of $385,000 with the FIA S&P 500 indexing strategy, or $221,000 greater than the S&P 500 Index total of $164,000. This results in total withdrawals of $1.3 million or $136,000 more than the S&P 500 Index. Furthermore, values of the FIA S&P 500 indexing strategy exceed those of the S&P 500 index each and every year by $85,000 to as much as $276,000.

Conclusion

Defensive investment and protection strategies are the key to the success of a retirement income plan. Just like a HECM mortgage strategy can be used to protect against sequence of returns risk, fixed index annuities can provide a buffer against stock market risk. Both strategies are timely given the current 12+-year bull market.

If you don’t want exposure to losses with a potential decrease in available investments to draw upon throughout retirement, are unsatisfied with taxable CD rates, and are seeking tax-deferred growth with an opportunity to participate in the upside potential of the stock market, then you may want to consider diversifying into one or more fixed index annuities.

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Annuities Deferred Income Annuities Fixed Index Annuities

Take Some Chips Off the Table and Add Them to Older Income FIAs

This article was originally published in, and has been reprinted with permission from, Retirement Daily.

Every year since 2014 when I purchased a fixed index annuity (FIA) with an income rider in my SEP-IRA, I have added $20,000 to it. Furthermore, I plan on continuing to do this until I retire.

Why did I purchase a FIA with an income rider in my SEP-IRA in 2014 and add to it each year? For the same reasons that I am making the recommendation to do so today.

Stock Market Euphoria is Cause for Evaluation

As I write this article, the Dow Jones Industrial Average (DJIA) is hovering at just below 31,000 after reaching an all-time high of 31,653.48 on February 22nd.  The DJIA increased 13,440 points, or 74%, since its Covid low of 18,213.65 just 11 months ago on March 23, 2020.

While Covid-19 cases, hospitalizations, and deaths have all recently dropped and more people are getting vaccinated which has contributed to the sizable stock market increase, the party and associated euphoria will not last forever. With the exception of last year’s first quarter drop, the stock market has been on steroids since hitting a low of 6,469.95 on March 6, 2009 after declining 52% in 17 months beginning in October, 2007.

The DJIA has increased 480% in the last 12 years, or 40% per year on average, which is obviously not sustainable. Do the terms “bear market” or “reversion to the mean” ring a bell?

Pivot Into Sustainable Income

I have been extolling the virtues of making sustainable income the cornerstone of a retirement income plan since 2009 when I began specializing in retirement income planning. The 52% stock market decline in 17 months, combined with the elimination of secure lifetime income provided by private pension plans, created a perfect storm for implementing this strategy.

While my clients are happy with the 12-year increase in their portfolio values, I know from many years of experience that this state of exuberance is often short-lived. The reality is that their equity allocation is greater than what is targeted for their portfolio in several cases.

As a retirement income planner, I look for windows of opportunity for my clients to transfer slivers of their investment portfolio from the unpredictable fluctuation of the stock market to fixed income annuities that are designed to provide sustainable income that they can depend on throughout retirement.

There are three types of fixed income annuities that can be employed for this purpose:  single premium immediate annuities (SPIAs), deferred income annuities (DIAs), and fixed index annuities (FIAs). Some FIAs have an income payout feature built into them while others require purchase of an income rider.

Add to Older Income FIAs

All payouts from fixed income annuities are calculated using mortality credits, or life expectancy, and current interest rates. If you invest in a SPIA or DIA today, your payout will be relatively low compared to three or more years ago because of declining interest rates. In the case of DIAs, this is true whether it is a new or an existing contract.

Income FIAs that were purchased between 2009 and 2018, including the one that I chose for my SEP-IRA in 2014, provide a unique opportunity for increased sustainable income payouts when new premium dollars are added compared to current SPIA, DIA and income FIA offerings. This is because the income payout for FIAs is calculated using a formula and the variables used to calculate the payout were more favorable and less likely to be tied to performance of the underlying contract accumulation value as is often done today.

The following four variables are responsible for higher income payouts in older income FIAs:

  • Higher interest rates in the growth phase
  • Wider availability of compound interest crediting in the growth phase
  • Ability to extend initial growth phase interest crediting from 10 to up to 20 years
  • Premium bonuses offered for longer periods of time, as much as five to seven contract years in some cases

Besides the more favorable variables, there was greater availability of flexible vs. single premium contracts. Funds cannot be added after the first contract year to a single-premium FIA. Flexible premium FIAs, on the other hand, allow for subsequent investments after the initial contract year. Some flexible premium FIAs do, however, place caps on the amounts of annual additions. Finally, qualified, or retirement plan annuities, such as my SEP-IRA, are subject to annual contribution limits.

Exercise Option to Extend Income FIA Growth Phase Interest Crediting

In addition to adding new premium dollars, anyone with an income FIA that was issued between 2009 and 2018 who has not begun taking income distributions should exercise their option to extend the initial growth phase interest crediting if this is available.

With the growing popularity of income FIAs beginning in 2009, a larger number of contracts offering the ability to extend interest crediting beyond 10 years are in play. If you have one of these contracts and have not started your lifetime income, it behooves you to exercise your interest crediting extension option.

This is a no-brainer since the crediting of additional interest, which can be for up to 10 years in some cases, will increase your income payout amount. The increase could be substantial if, for example, your contract provides for 8% compound interest crediting, you extend the growth period from 10 to 20 years, and you defer your lifetime income withdrawal start date.

Opportune Time to Purchase or Add Funds to Fixed Income Annuities

This is a great time to purchase or add funds to fixed income annuities as part of an overall retirement income plan given the continued escalating stock market highs. Shifting a portion of one’s investment portfolio to sustainable lifetime income at opportune moments is a proven long-term strategy, especially if you are within 20 years of, or in, retirement.

Employing this strategy can enable you to accomplish two important goals shared by all individuals doing retirement income planning: portfolio risk reduction and decreased likelihood of running out of money in retirement.

Surveys as well as personal and client experience show that having predictable retirement income results in reduced short- and long-term stress levels, fewer cases of insomnia, and less health issues in general. This unequivocally trumps the often short-lived euphoria associated with increasing portfolio values in a bull market.

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Uneasy About the “A” Word? You’re Not Alone

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Tilney, a highly-regarded financial planning firm in England where workers are automatically enrolled in employer pension plans unless they opt out, surveyed 1,300 employees in 2018 regarding what they planned to do with their pension when they retire. The results were as follows:

  • 40% said they didn’t know what they would do.
  • 22% said they expected to keep most of it invested, taking some withdrawals.
  • 10% would potentially cash it all in.
  • 10% would use the pension to buy an annuity.

When the word “annuity” was removed as an option and replaced with a “pension that provided a guaranteed income for life,” 79% of respondents said that this was more appealing than a plan where the value and income varied each year. This was the result despite the disclosure that a traditional investment plan offered the prospect for higher returns.

Income Optimization is the Appropriate Benchmark

Annuities have long been misunderstood. Fixed income annuities in particular are often rebuffed by investment professionals with little or no annuity education whose goal is to maximize investments under management and who don’t practice holistic retirement income planning.

Their use of investment returns as a frame of reference results in inevitable non-apples-to-apples comparisons to traditional equity-based investment portfolios. These individuals fail to acknowledge the fact that it’s impossible to calculate the return of a fixed income annuity until an annuitant has passed.

Income optimization, rather than investment return, is the appropriate benchmark that should be used when evaluating fixed income annuities for inclusion in a retirement income plan. The goal is to design a comprehensive strategy that uses the least amount of assets to purchase the greatest amount of sustainable after-tax lifetime income that’s projected to pay for expenses not covered by distributions from investment and other assets.

Purchasing Guaranteed Lifetime Income is Unnatural

In addition to being misunderstood, the concept of purchasing guaranteed lifetime income, especially when the income start date is deferred, is unnatural for most people. That’s generally the case until they realize that’s exactly what they’re doing with Social Security. In order to receive Social Security retirement benefits, you must purchase them.

What do I mean? Either your salary is reduced by a deduction for Social Security tax or, if self-employed, you’re subject to a self-employment tax until the maximum Social Security wage base, currently $132,900, is reached. Social Security withholding and/or self-employment tax is used to fund Social Security retirement benefits. In essence, you’re purchasing your benefits.

It’s more difficult to pull the trigger when you purchase sustainable lifetime income with a fixed income annuity because you’re not exchanging a lump sum for an investment of equal value unless you purchase a fixed index annuity (FIA). Instead, you’re entering into a contract in which a promise is made by a life insurance company to pay you a periodic income stream for life or a specified number of months or years beginning at a future date.

The contract is irrevocable in the case of single premium immediate annuities (SPIAs) and deferred income annuities (DIAs), i.e., your premiums won’t be returned to you by the insurance company unless you’re within the “free look” period. This is generally 10 days following the purchase date with up to 30 days for seniors in California.

Fixed Income Annuities Designed for Sustainable Lifetime Income

When presented in the context of retirement income planning, fixed income annuities have proven to be the most appropriate and natural commercial solution for providing sustainable lifetime income. The three types of fixed income annuities can be used individually, or in combination, to provide a hedge against the unpredictable stock market.

Fixed income annuities are often used in conjunction with other sources of guaranteed income such as Social Security and private or government pensions to allow retirees to sleep better at night. Nonqualified SPIAs and DIAs enjoy a competitive edge since a portion of each income payment is nontaxable.

Fixed Income Annuity or Pension That Provides Guaranteed Income for Life?

Assuming that you’re planning for retirement, would you rather purchase a lifetime fixed income annuity or a pension that provides guaranteed income for life? This is one decision you don’t have to worry about making since they both provide the same benefit, i.e., sustainable lifetime income that’s unaffected by the fluctuations of the stock market.

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Annuities Fixed Index Annuities

Retain Your Gains with Fixed Index Annuities

Retain Your Gains
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Some nerves were recently rattled when the Dow Jones Industrial Average (DJIA) declined 2,052 points, or 7.6%, in six trading sessions, going from a high of 26,952 on October 3rd to a low of 24,900 on October 11th. The loss increased to 2,830 points, or 10.5%, when the DJIA hit a low of 24,122 yesterday before it closed at 24,443.

Given its 9.5-year ascent of 317%, or 33% per year, from its low of 6,470 on March 6, 2009 to its recent high, many people are wondering more and more if this is the beginning of a long-overdue major correction.

What most people don’t realize is that when the stock market experiences a sizable decline, their investments need to work a lot harder just to get back to where they were before the downturn. As an example, suppose you invested $500,000 in a DJIA portfolio on December 31, 2007. The DJIA finished down 34% in 2008, resulting in your portfolio being worth $330,000 on December 31, 2008. In order to recover its loss of $170,000, your portfolio would need to increase 52%.

Fixed index annuities, or FIAs, are insulated from stock market declines. Unlike investments in stocks, bonds, mutual funds, index funds, and exchange traded funds that fluctuate in value, the value of FIAs either increase or remain unchanged.

Value Increases When Stock Market Increases

The performance of a FIA is tied to the performance of stock market indices associated with one or more indexing strategies chosen by you. Interest is credited annually to your contract value based on performance of each selected indexing strategy during the previous contract year.

Interest will be credited to your FIA account, or accumulation value, whenever the performance of a chosen indexing strategy has been positive during the previous contract year. The amount of interest that’s credited is generally subject to a cap rate, or preset maximum amount.

Value is Unchanged When Stock Market Declines

Whenever the value of an indexing strategy is either unchanged or has declined from the previous contract year, your FIA will be credited with no interest at the end of the contract year. The value is simply unchanged from what it was a year ago.

To illustrate, suppose that instead of investing $500,000 in a DJIA portfolio on December 31, 2007, you invested $500,000 in XYZ fixed index annuity. Let’s assume that you allocated 100% of your investment to the DJIA indexing strategy which declined 34% in 2008.

No interest would be credited to your FIA contract value in 2008. Furthermore, you wouldn’t be penalized by the negative performance of your strategy. Unlike a direct investment in a DJIA portfolio which would have been worth $330,000 on December 31, 2008, the value of your FIA would have been $500,000.

Gains are Retained

Unlike other types of investments, FIAs are unaffected by stock market declines. While annual gains from increases in indexing strategies are limited by cap rates, they’re locked in.

The ability to shelter gains from subsequent losses isn’t available with most other types of investments. This benefit can be especially important for older retired individuals who don’t have a long time horizon to recover from sizable stock market losses. Never underestimate peace of mind.

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Annuities Fixed Index Annuities

Income Rider is Everything When it Comes to FIAs

When I think about and evaluate insurance riders for my clients, I look at the potential value my client will receive from adding one or more of them to a particular insurance contract. Insurance riders are optional benefits that aren’t included in the basic policy that may be purchased at additional cost. A rider typically provides for benefits that will be paid, or features that will kick in, prior to the occurrence of the insurable event covered by the basic policy.

Insurance Riders

Riders are available on most types of insurance policies including life, disability, long-term care, homeowners, and auto. Each one serves a specific purpose and is triggered by the occurrence of a specified event. Examples of life insurance riders include waiver of premium, disability income, guaranteed insurability, and accelerated death benefit.

When deciding whether to add a particular rider to an insurance contract, you will be more likely to do so if you perceive that the event covered by the rider may occur and the potential benefits are significant compared to the additional premium. It’s similar to buying a new car and deciding if you want the one with or without the sunroof. You will opt for the car with the sunroof if you perceive it to be of value and it fits in your budget.

Sustainable Lifetime Income with Flexible Start Date

There’s one type of insurance contract where the primary rider supersedes the underlying provisions of the basic contract in terms of the value that it’s intended to provide to the contract owner. It’s so important that I screen for the most appropriate rider to meet my clients’ needs before evaluating the underlying contract. I’m referring to the income rider, sometimes known as the lifetime income benefit rider or guaranteed minimum withdrawal benefit (GMWB) rider that’s available with fixed index annuities (FIAs).

When purchased, an income rider provides a significant and unique benefit from a retirement income planning perspective:  sustainable lifetime income for the owner(s) of the contract beginning at a date chosen by the owner. Unlike a deferred income annuity (DIA) where the income start date must be identified on the application, the income start date with a FIA is flexible.

A FIA owner may elect to begin receiving income distributions at any time in the future, typically beginning one year after the contract date. The longer the income start date is deferred, the greater will be the periodic lifetime income payment amount. Furthermore, with a FIA, there’s no requirement to ever begin taking income distributions.

Accumulation Value Provides Additional Security

The other noteworthy distinction of a FIA from a DIA is the presence of an accumulation, or cash, value. The accumulation value is increased by premiums, premium bonuses, and contractually-defined periodic interest credits tied to the performance of selected stock indices. It’s decreased by income and other withdrawals and income rider and surrender charges. Any remaining accumulation value is paid to the contract’s beneficiaries when the owner(s) die.

Assuming that there are no non-income withdrawals taken from a FIA after income withdrawals begin, the periodic income withdrawal amount that’s paid when the contract owner elects to begin taking income will be the same amount for the duration of the contract owner(s)’ life or lives. Income will continue to be paid even if there’s no remaining accumulation value.

Income Rider Should be the Focus

Indexing strategies are the focal point of a typical FIA contract in terms of number of pages devoted to them. It’s ironic that, despite their importance, income riders are usually a handful of pages and are often buried toward the back of a FIA contract. In one contract, the income rider is pages 43 – 46 of a 62-page contract. The rider in another one is pages 48 – 56 of a 65-page contract.  In a third contract that features it more prominently, there’s a three-page income rider specifications page that begins on the sixth page and a five-page income rider section that begins on page 32 of a 36-page contract.

Looking at it another way, it can be argued that the income rider on a FIA contract is an example of the Pareto principle, also known as the 80-20 rule. 20% or less of the number of pages is devoted to the income rider which is responsible for 80% or more of the value of the contract, i.e., sustainable lifetime income distributions. Furthermore, unlike other types of insurance contracts where benefits may never be paid, the benefit of a FIA contract with an income rider, i.e., income, is payable for life beginning at the owner’s discretion.

Given the fact that, like all riders, there’s an additional charge tacked onto a FIA contract for an income rider, the primary reason that individuals purchase FIAs with income riders is for sustainable lifetime income beginning at a date of their choice. The main feature of the basic contract, i.e., stability of the contract value, is secondary to the availability of a sustainable lifetime income stream.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Deferred Income Annuities Comparing More Favorably with FIAs with Income Riders

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If you’re planning for retirement and you want to receive sustainable lifetime income beginning at a future date, deferred income annuities (DIAs) and fixed index annuities (FIAs) with income riders are potential suitable choices. These are the two types of deferred fixed income annuities that are sold by life insurance companies. The question is which one better meets your needs?

This isn’t an easy question to answer, especially if you don’t work with fixed income annuities on a regular basis. Furthermore, the answer to this question has become more complicated the last four years. While the choice is still driven primarily by one’s personal financial situation, and although FIAs with income riders continue to offer more features than DIAs (see FIAs with Income Riders vs. DIAs:  Which is Right for You? – Part 1 of 5), changes in the variables used to calculate income payouts from FIA riders combined with increased income rider charges have reduced the attractiveness of FIAs with income riders compared to DIAs.

Reduced Income Payouts

When I first began writing about, and working with, fixed income annuities in 2009, there were a handful of DIA products to choose from. Income payouts from the ones that were available were sometimes greater, and were often less, than those from FIAs with identical premium amounts, premium timing, and income start dates. The presence of an accumulation value with growth potential combined with a flexible income start date with a FIA vs. an optional pre-payout return of death benefit and a fixed income start date with a DIA often favored FIAs with income riders.

Beginning in 2011, in response to declining interest rates, life insurance companies began reducing income payouts on fixed income annuities. This is easy to do with DIAs since insurance companies simply declare a new payout rate.

FIA Income Rider Payout Reductions Less Transparent Than DIAs

FIA income payout reductions have been less transparent than DIAs due to the fact that income needs to be determined as part of a side “income account value” calculation that’s separate and apart from a FIA’s accumulation value, with multiple variables coming into play. Carriers can pick and choose the variables that they adjust to achieve desired income payout results.

Assuming no additional premiums or withdrawals prior to the income start date, the variables include the following:

  • Roll-up, or interest, rate
  • Type of roll-up rate, i.e., simple or compound
  • Roll- up rate term, e.g., 10 years, 20 years, age 85, etc.
  • Availability of premium bonuses
  • Inclusion/exclusion of premium bonuses in income account value calculation
  • Lifetime income withdrawal percentages

FIA and DIA income rider payouts have also been reduced in the last year in response to IRS’ revised mortality tables with longer life expectancies.

FIA Reduced Accumulation Values

While FIA accumulation values have generally increased in recent years as a result of positive performance of stock market indices to which FIA interest crediting is tied, the increases have been diluted by increased income rider charges resulting from increased income rider charge percentages beginning in 2011. This is in addition to increasing income rider charges resulting from annual income account value increases.

Charges that were in the 0.65% to 0.75% of income account value range increased to 0.95% or more in some cases. Although it doesn’t affect income payouts, increased rider charges result in erosion of a FIA’s accumulation value and death benefit.

Furthermore, the income rider charges for some FIA income riders have the potential to double after a specified period of time. With one product, the carrier will declare a new income rider charge in year eleven with a maximum charge of double the original income rider charge percentage if you want to extend the application of the roll-up rate to the income account value for an additional ten years beyond the first ten years of the contract. Although you will receive a higher income payout by doing this, the accumulation value of your contact will be adversely affected.

Income Optimization is Still the Name of the Game

As stated at the beginning of this post, DIAs and FIAs with income riders are potentially suitable choices if you’re planning for retirement and you want to receive sustainable lifetime income beginning at a future date. While income payouts aren’t as generous as they were four years ago, income optimization is still the name of the game.

Income optimization needs to be driven by your targeted income start date and projected ongoing retirement income needs. Income payouts beginning at different ages with different DIAs and FIAs should be compared. Whereas one product might have the highest income payout beginning at age 65, this may not be the case if the income start date is deferred to age 75.

A DIA vs. FIA comparison should be done on an after-tax basis for nonretirement accounts. DIAs apply an “exclusion ratio” to the income payout for these types of accounts that results in the exemption of the portion of payouts attributable to a return of principal from taxation.

FIAs often have the edge In situations where you’re not certain when you will need your income due to their flexible income start date. Multiple DIAs with different income start dates can also provide income start date flexibility. Although most DIAs have a fixed income start date, some offer flexibility, allowing income to begin within a specified number of years before or after their contractual start date.

Side-by-side comparisons of FIAs with income riders vs. DIAs should always be performed in order to determine which one makes the most sense in a particular situation. Combinations of multiple FIAs and/or DIAs with difference income start dates and premium amounts can be used to dovetail with projected retirement expense needs while also providing diversification.

Categories
Annuities Fixed Index Annuities

It’s a Good Time to Own a FIA with an Income Rider

Senior couple trying on sunglasses, smiling

Although the Dow Jones Industrial Average (DJIA), with its close of 16,472 on Friday, is up 1,000 points from its August 24th low of 15,370, it’s still down almost 2,000 points, or 10%, from its May 19th high of 18,351. Putting things in perspective, a 10% decline is an overdue correction given the fact that the DJIA has experienced six straight years of gains, ranging from 5.5% to 26.5%.

Nonetheless, there are a lot of people who are approaching retirement, have recently retired, or have been retired for years, whose appetite for the stock market roller coaster isn’t what it use to be. With reduced sources of dependable income such as pensions, potential large out-of-pocket extended care expenses, uncertain inflation and income tax rates, and the possibility of being unemployed for 30 to 40 years, who can blame them?

Fixed Index Annuities Insulated from Stock Market Declines

If you’re in this situation and you own a fixed index annuity, or FIA, especially one with an income rider, you’re probably sleeping better at night than a lot of other people.  For starters, FIAs are insulated from stock market declines. Interest is credited each contract year based on a fixed account if selected and performance of chosen stock market indices and index crediting methods, with rates capped at specified amounts.  No interest is credited in years when performance is negative.

As an example, let’s say that you invested $100,000 in a fixed index annuity on August 24, 2014 and tied the performance to three different stock market indices and index crediting methods. On August 24, 2015, the contract anniversary date, the performance of each of the three indices and associated crediting methods was negative. When you receive your annual statement, no interest will be credited to the value of your contract.

Lifetime Income Unaffected by Income Rider Charges

If your FIA contract in the foregoing example includes an income rider, the value of your contract probably declined from the previous year, even though you weren’t penalized for negative performance and even if you didn’t take any withdrawals. This is due to the fact that an income rider charge, that’s generally in the range of 0.75% to 1.25% of either the income account value or accumulation value of your contract, is deducted from the accumulation value on a monthly, quarterly, or annual basis.

Assuming that you added an income rider to your FIA contract for the purpose of receiving a known future sustainable lifetime income stream with a flexible income start date, the income rider charge won’t reduce the amount of income that you will ultimately receive. While it will reduce the accumulation value of your contract, this won’t come into play unless you and your spouse, if married, die. When this occurs, the death benefit that’s paid to your beneficiaries, which is generally equal to the accumulation value of your contract, will be reduced accordingly.

Let the Good Times Roll

This is a good time to own a FIA, especially one with an income rider. Even if the DJIA declines three years in a row as it did from 2000 to 2002 or if it declines 34% in one year, as it did in 2008, the value of your contract will be unaffected by performance.  Whether you’re a current or a future retiree, if your contract includes an income rider, you will also receive the ultimate benefit:  a known income stream beginning at the date of your choosing for the rest of your life. Let the good times roll.

Categories
Annuities Fixed Index Annuities

Don’t Underestimate the Power of Zero

Every year since my wife and I began investing in fixed index annuities (FIAs) with income riders several years ago, we’ve received annual statements on the anniversary date of each contract. A reconciliation of the beginning- to the end-of-the-contract-year accumulation value is a key component of each statement. This includes additions, or premiums, premium bonuses, interest credits, withdrawals, surrender charges, and income rider charges.

Distinguishing Feature of Fixed Index Annuities

Interest credits and the methodology used to calculate them is a distinguishing feature of FIAs. The amount of interest credited is primarily dependent upon the performance of a stock market index associated with one or more selected indexing strategies during the previous contract year.

There’s generally a cap rate, or preset maximum amount of interest that will be credited for a particular strategy each year. No interest is credited in years where there is negative performance. The current interest rate of a fixed account also affects total interest credited to the extent that this has been selected as part of one’s overall allocation in a particular year.

The annual interest credits on my wife and my FIA contracts have exceeded our income rider charges as a result of the recent performance of the stock market. This has resulted in an increase in the accumulation value and death benefit of our contracts each year, ignoring additions and premium bonuses.

Protection from Stock Market Downturns

Although we’ve experienced, and are delighted by, the annual net increases in the value of our FIA contracts, my wife and I have yet to realize the unique benefit of owning a FIA compared to other types of investments, i.e., protection from inevitable stock market downturns. Unlike direct investments in mutual funds and exchange traded funds that decrease as well as increase in value, FIAs are insulated from market declines. This is sometimes referred to as the “power of zero.”

How is a FIA owner protected from market downturns? As previously stated, no interest is credited to individual indexing strategies in contract years when performance is negative. In other words, index credits will never be less than zero. This is very comforting when this occurs in a negative year, let alone in a prolonged bear market.

To appreciate this, let’s suppose that you invested in an exchange traded fund tied to the S&P 500 that experienced a decline of 20% in one year. You would need to realize a return of 25% just to break even. This turnaround could potentially take several years. On the other hand, the portion of a FIA tied to the same S&P 500 index would be unaffected by the 20% decline. This would simply be a non-event with no interest credited in the contract year in which this occurred.

In the foregoing example, assuming that 100% of your FIA was tied to the S&P 500 index and there were no additions or withdrawals, your end-of-the-contract-year accumulation value would be identical to what it was at the beginning of the year unless your contract includes an income rider. In this case, your contract’s accumulation value would be reduced by the income rider charge, which generally is 0.5% to 1% of the contract’s income account value. Although an income rider charge reduces a contract’s accumulation value, it has no affect on the amount of income distributions you will ultimately receive.

If you’re approaching, or are in, retirement, or if you’re more sensitive to loss than to gain, FIAs may be an appropriate choice for a portion of your investment portfolio. Don’t underestimate the power of zero.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Looking for a Deferred Fixed Income Annuity on Steroids?

Deferred income annuities (DIAs) have been getting a lot of attention since the Treasury and IRS finalized a regulation in July, 2014 blessing the use of qualified longevity annuity contracts, or “QLACs.” A QLAC is a DIA that’s held in a qualified retirement plan such as a traditional IRA with a lifetime income start date that can begin up to age 85. It’s subject to an investment limitation of the lesser of $125,000 or 25% of one’s retirement plan balance.

Fixed Income Annuity Hierarchy

For individuals concerned about longevity who are looking for a sustainable source of income they can’t outlive, fixed income annuities are an appropriate solution for a portion of a retirement income plan. There are three types to choose from:

  1. Immediate annuities
  2. Deferred income annuities (DIAs)
  3. Fixed index annuities (FIAs) with income riders

The overriding goal when choosing fixed income annuities is to match after-tax income payouts to periodic amounts needed to pay for specified projected expenses using the least amount of funds. Immediate annuities, with a payout that begins one month after purchase date, are appropriate for individuals on the cusp of retirement or who are already retired. DIAs and FIAs with income riders, with their built-in deferred income start dates, are suitable whenever income can be deferred for at least five years, preferably longer.

Assuming there isn’t an immediate need for income, a deferred income strategy is generally the way to go when it comes to fixed income annuities. This includes one or more DIAs or FIAs with income riders. Which should you choose?

DIA Considerations

As a general rule, DIAs and FIAs are both qualified to fulfill the overriding income/expense matching goal. Both offer lifetime income payouts. If your objective is deferred lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare income payouts.

DIAs can also be purchased for a specified term of months or years. This can be important when there are projected spikes in expenses for a limited period of time.

DIAs may also be favored when used in a nonretirement account since a portion of their income is treated as a nontaxable return of principal. Finally, if you’re looking to defer the income start date beyond the mandatory age of 70-1/2 for a limited portion of a traditional IRA, a QLAC, which is a specialized DIA, may be an appropriate solution.

Let’s suppose that you’re a number of years away from retirement and you’re not sure when you want to retire or how much income you will need each year. A DIA may not be your best choice since you lock in a specified income start date and income payout at the time of investment with most DIAs.

FIA with Income Rider Features

FIAs with income riders hold a distinct advantage over DIAs when it comes to income start date flexibility. Unlike a DIA, there’s no requirement to specify the date that you will begin receiving income when you purchase a FIA.

The longer you hold off on taking income, the larger the periodic payment you will receive. Furthermore, there’s no stipulation that you ever need to take income withdrawals. This is ideal when planning for retirement income needs ten or more years down the road.

For individuals not comfortable with exchanging a lump sum for the promise of a future income stream beginning at a specified date, i.e., a DIA, a FIA with its defined accumulation value and death benefit, offers an attractive alternative assuming similar income payouts. While an optional death benefit feature can be purchased with a DIA to provide a return of premium to one or more beneficiaries prior to the income start date, this will reduce the ongoing income payout amount.

A FIA also has a defined investment, or accumulation, value that equates to a death benefit. Unlike with most DIAs, flexible-premium FIAs offer the ability to make additional investments that will increase income withdrawal amounts in addition to the investment value.

Some FIAs offer a premium bonus that matches a limited percentage, e.g., 5%, of your initial, as well as subsequent, investments for a specified period of time. The accumulation value is also increased by contractually-defined periodic interest credits tied to the performance of selected stock indices.

Finally, a FIA’s accumulation value is reduced by withdrawals and surrender and income rider charges. Any remaining accumulation value is paid to beneficiaries upon the death of the owner(s).

Summary

A comprehensive retirement income plan is a prerequisite for determining the type(s), investment and income payout timing, and investment amounts of fixed income annuities to match after-tax income payouts with projected expense needs assuming that longevity is a concern. If you don’t have an immediate need for income and your objective is lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare potential income payouts.

With their ability to match a spike in expenses for a limited period of time, term DIAs offer a unique solution. When it comes to lifetime income payouts, FIAs with income riders, with their flexible income start date and accumulation value and associated built-in death benefit, are, in effect, a DIA on steroids.

Given the foregoing advantages and assuming similar income payouts, FIAs with income riders generally offer a more comprehensive solution for fulfilling sustainable lifetime income needs, with the possibility of a larger death benefit. A potential exception would be when investing in a nonretirement account for higher tax bracket individuals subject to one’s preference for a flexible income start date and accumulation value/death benefit in a particular situation.

Last, but not least, all proposed annuity solutions should be subjected to a thorough due diligence review and analysis of individual life insurance companies and products before purchasing any annuity contracts.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Make Sustainable Income a Cornerstone of Your Portfolio Beginning at 45

Dollar bills falling in or flying out of a pink piggy bank in a fantasy landscape

A common theme I hear when I talk to retirees is “I wish I would have started saving sooner for retirement.”

There’s an underlying feeling of guilt that’s expressed each time this statement is uttered. The implication is that the individual had the ability to save more for retirement but chose not to do so.

While it’s ultimately the responsibility of each of us to make sure that we have sufficient funds to pay for our needs for the duration of retirement, it’s extremely difficult, if not impossible in many cases, to achieve this goal without proper guidance. Saving for retirement requires a totally different mindset than saving for any other financial goal.

It’s All about Income Replacement

Most financial goals require planning for the availability of a lump sum at a future date that will either be spent (a) one time, e.g., a down payment on a house or (b) over a specified number of years, e.g., college education. Retirement, on the other hand, typically requires you to replace one source of income, i.e., salary, or draw in the case of self-employed individuals, with multiple sources of income. Furthermore, the replacement income sources must be sustainable for the duration of retirement which is unknown.

You need to use the right tools for the job at hand if you want to achieve a successful result. Retirement is no exception. Given the fact that sustainable income is the name of the game, it makes sense that investments that are allocated for retirement are designed to provide you with a targeted amount of after-tax income that will meet your needs after other sources of sustainable income, e.g., Social Security, are taken into consideration.

Timing is Key

Fixed income annuities are well-suited for this purpose since they’re designed to provide sustainable income for the duration of retirement. Deferred fixed income annuities, including fixed index annuities (FIAs) with income riders and deferred income annuities (DIAs) make the most sense due to the fact that they require the least amount of funds to generate future known income amounts compared to other types of investments.

Even though FIAs with income riders and DIAs allow you to minimize initial and ongoing investment amounts compared to other types of investments, the potential length of retirement requires you to start early if you want to generate enough income to meet your needs.

You simply can’t begin saving a relatively small portion of your salary ten years before you plan to retire and expect your savings to provide you with adequate retirement income for 25 or more years. Age 45 isn’t too early to start in most cases.

FIAs with Income Riders vs. DIAs

If you establish a sustainable income plan before age 55, I generally recommend investing in one or more FIAs with income riders vs. DIAs to provide you with the most flexibility. For starters, unlike DIAs which generally have fixed income start dates, FIAs don’t require you to begin income withdrawals at a specified date. This is a distinct advantage when you don’t know if you’re going to retire at 60, 65, or 70 and you don’t necessarily know all of your potential sources, timing, and amounts of other retirement income.

Additional funds can periodically be added to flexible premium FIAs that generally isn’t possible with DIAs. Care must be taken, however, when researching these types of FIAs since some limit the number of years that additional premiums can be added or subsequent purchase amounts. See How Flexible are Flexible Premium Deferred Annuities?

Another benefit of FIAs is their accumulation value which can increase over time and provide a pre- and post-income withdrawal death benefit. In addition to the lack of an accumulation value, a death benefit with DIAs is generally optional and is limited to the amount of premium invested in exchange for a reduced income payout.

Finally, in addition to generating sustainable retirement income, investment in FIAs with income riders and DIAs reduces portfolio risk to the extent that funds from equity investments, e.g., stocks and equity exchange-traded and mutual funds, are used.

In conclusion, it’s not only about minimizing regrets regarding how soon you started saving for retirement when you’re retired. Making sustainable income a cornerstone of your portfolio using investments that are suited for this purpose, i.e., fixed income annuities, will help you sleep better at night – before and after you retire.

Categories
Annuities Fixed Index Annuities Retirement Income Planning

Looking for a Pension with a Flexible Start Date?

Focus on and take control of your retirement made in 2d software

If you want peace of mind when you retire, you need to have a plan that will generate sustainable income streams that will cover a large portion of your fixed and discretionary expenses. Income tax planning is critical since your income needs to be calculated net of income tax to determine the amount that will be available for spending.

A sustainable income stream is simply a regular series of payments that, once it begins, will continue for the rest of your life. An ideal sustainable income stream is one that’s calculated using life expectancy and has a flexible start date. The longer you wait to turn on your income, the greater the periodic payment.

Social Security is a great example of a sustainable income stream that meets these criteria. Although you can begin collecting as early as age 62, you can also delay your start date to as late as age 70. The longer you wait, the greater your monthly payment. Assuming a full retirement age of 67, your benefit will be 80% greater if you delay your start date from 62 to age 70, excluding cost of living adjustments.

While Social Security is an important cornerstone of most retirement income plans, it generally needs to be supplemented by other sources of sustainable income. Even if you qualify for the maximum monthly benefit of $2,663 assuming you reach full retirement age in 2015, your annual benefits of approximately $32,000 may be reduced to as little as $21,000 after income tax, depending on your other income and income tax bracket.

Fortunately, there’s another source of sustainable income beside Social Security that’s calculated using life expectancy and also features a flexible start date. It’s offered by life insurance companies and is called a fixed index annuity (FIA) with an income rider.

Unlike the start date of Social Security which is limited to a window of eight years (age 62 to 70), a FIA income rider start date is open-ended. Generally speaking, the only requirement is that you must be at least age 50 when you begin receiving income. Assuming you meet this condition, you can start your lifetime income stream at any age you choose.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Other factors that will influence your income payment are the age at which you purchase your FIA, your original investment amount, additional investments if permitted, premium bonus when applicable, and non-income withdrawals. The calculation of your payment amount is defined by the income rider provision of your FIA’s contract.

Since the calculation of your payment amount is contractually defined, you can determine the amount of initial and ongoing investments required to provide you with a target amount of income beginning at one or more specified ages of your choice before you purchase a FIA. Furthermore, if you need different amounts of income beginning at different ages, you may want to consider investing in two or more FIAs with income riders.

In addition to meeting the criteria of an ideal sustainable income stream, i.e., one that’s calculated using life expectancy and has a flexible start date, a FIA with an income rider offers another benefit that can be important where there are potential beneficiaries. Unlike other types of fixed income annuities, i.e., immediate and deferred income annuities, a FIA has an accumulation, or cash, value.

The accumulation value increases by purchases and premium bonuses and decreases by income and non-income withdrawals and income rider and surrender charges. Any accumulation value remaining at the death of the contract owner(s) will be paid as a death benefit to the beneficiaries.

As stated at the beginning of this post, income tax planning is a critical part of the retirement income planning process since your income needs to be calculated net of income tax to determine the amount that will be available for spending. All income payments from FIAs with income riders are taxable as ordinary income. This is true whether they’re held in traditional IRAs and other types of retirement plans or as nonqualified, i.e., nonretirement, investments.

If you’re looking for a pension with a flexible start date to increase the amount of your fixed and discretionary expenses that are covered by sustainable income throughout your retirement, one or more FIAs with an income rider may meet your needs.

Categories
Annuities Fixed Index Annuities Retirement Income Planning

How Flexible are Flexible Premium Deferred Annuities?

When planning for retirement, you need to generate sustainable income that will meet your projected inflation-adjusted financial needs during various stages. This often requires multiple income-generating sources that ideally start, and potentially stop, to match your projected needs at different stages of retirement.

A diversified portfolio of fixed income investments that’s part of your overall portfolio generally needs to be designed to provide the desired after-tax income amounts and timing of same. The planning is complicated, should begin well in advance of retirement, and needs to be monitored and updated on a regular basis.

One popular investment that’s designed for the fixed income portion of a retirement income plan is a fixed index annuity (“FIA”) with an income rider. When you invest in a FIA, you’re purchasing a deferred annuity. As defined in the Glossary, a deferred annuity is an annuity that doesn’t mature or begin making payments until some future date.

Deferred Annuity Types

There are two types of deferred annuities, both of which are suitable for inclusion in a retirement income plan: (a) single premium deferred annuity (“SPDA”) and (b) flexible premium deferred annuity (“FPDA”). The basic difference between the two is the allowable investment frequency. A SPDA is a one-time investment whereas a FPDA provides for multiple investments in the same annuity.

The key to understanding FPDA’s, including how they will fit into a particular retirement income plan, is that flexibility is in the eye of the beholder, or, in this case, the insurance carrier that issues a particular product. While a FPDA by definition allows for multiple premiums, the number of years the additional premiums may be added and/or the premium amounts are often limited by the terms of an annuity contract. This can be problematic where ongoing investments of specific amounts are required to achieve a targeted level of retirement income.

Types of Flexibility Restrictions

While many FPDA’s provide for indefinite additional investments, several have a limited defined window of opportunity. To give you an idea of the possibilities, let’s take a look at the FIA offerings available through the life insurance agency with which I’m associated.

Of the 52 FIA’s currently offered by 14 carriers, all of which are highly rated, 25 are SPDA’s and 27, or 52%, are FPDA’s. 16 of the 27, or 59%, of the FPDA’s have no restrictions regarding the number of years additional premiums may be added or the amounts of same.

That leaves 11 FPDA’s with restrictions, seven of which limit the number of years that additional premiums may be added and four limit the additional premium amount. The seven FPDA’s that limit the number of years uses either one or three years as the limitation. The four that limit the premium amount are all offered by the same carrier which limits additional premiums to $25,000 per year.

Retirement income planning requires flexibility. The ability to make unlimited additional investments after the first contract year without restriction as to dollar amount is an important consideration in many cases when evaluating FIA’s with income riders. In summary, the type of fixed income annuity and product that you’re evaluating needs to dovetail with your projected financial needs to increase your opportunity for success.

Categories
Annuities Fixed Index Annuities

Fixed Index Annuity Income Rider Charge – Is It Worth It? – Part 2 of 2

Part 1 of this post explained the benefits of attaching an income rider to a fixed index annuity (“FIA”). It also discussed the charge for this rider, including how it’s calculated. Now we come to the crux of the matter – is a FIA income rider charge worth it?

Before answering this question, I want to make it clear that the charge doesn’t reduce the lifetime income, or lifetime retirement paycheck (“LRP”) amount that you will receive. It’s deducted from the accumulation value of your FIA, or value of your FIA before any applicable surrender charges. As explained in Part 1, the income account value is used to calculate the amount of your LRP and is separate and apart from the accumulation value of your annuity contract.

Not to state the obvious, however, when you purchase something for yourself, you generally do so only if you plan on using it or benefiting from it in some way. This applies to a FIA income rider. The reason that people purchase a FIA with an income rider is to obtain the security that no matter what happens with the rest of their investment portfolio, subject to individual life insurance company claims-paying abilities, they will receive guaranteed lifetime income beginning at a flexible income start date, with the amount of income increasing the longer the start date is deferred.

Furthermore, per Part 1, one of the five benefits offered by an income rider is the ability to calculate the LRP amount that you will receive beginning on a specified future date on the date of purchase. When you invest in a FIA and tack on an optional income rider, your retirement income planner should be able to show you (a) the amount of annual income that you will receive beginning on different dates with specified initial and additional purchase amounts and (b) the amount of your projected retirement income need that will be met by your FIA income.

Assuming your goal is to receive a specific amount of income each year beginning at a specified future date, you won’t withdraw funds from the accumulation value of your FIA before or after your income start date. If you do so, the income account value will decrease by the amount of your withdrawals, decreasing your LRP amount.

Assuming you won’t be withdrawing funds from the accumulation value of your FIA and you will only be using your FIA to generate lifetime income, the accumulation value will be of secondary importance to you during your lifetime. If there’s a chance that you may take withdrawals from your accumulation value, you shouldn’t be purchasing an FIA with an income rider.

With an income rider, once you start receiving income from your contract, you will continue to do so for the rest of your life even if the accumulation value has been reduced to $0 as a result of income withdrawals and income rider charges. Assuming that you use your income rider as intended, receiving lifetime income without taking any withdrawals from the accumulation value of your contract, the primary benefit of your contract’s accumulation value is as a potential death benefit to your beneficiaries. Keeping in mind that income distributions reduce accumulation value, the latter may be minimal or potentially depleted in the event that there have been ongoing income distributions for many years.

Assuming (a) you value the five benefits of a FIA income rider presented in Part 1, (b) you understand that the income rider charge won’t affect the amount of your lifetime income, (c) you recognize that the accumulation value is of secondary importance, and (d) the income rider charge is competitive with other FIA income rider charges assessed by similarly-rated life insurance carriers that will pay a similar amount of income, you will probably conclude that the income rider charge is a small price to pay to obtain the unique combination of benefits offered by a FIA income rider.

Categories
Annuities Fixed Index Annuities

Fixed Index Annuity Income Rider Charge – Is It Worth It? – Part 1 of 2

Although fixed index annuities (“FIA’s”) offer a number of attractive features, not the least of which is protection from stock market downturns, I recommend them as a sustainable lifetime income strategy for a portion of my retirement income planning clients’ investment portfolios when appropriate. In order to obtain this popular benefit, it’s generally, although not always, necessary to apply for an optional income rider when you apply for a FIA.

When you add an income rider, you turbocharge your FIA. A FIA income rider offers the following five benefits that, when taken as a whole, cannot be duplicated by any other investment:

  1. Guaranteed, subject to individual life insurance company claims-paying abilities, lifetime income or lifetime retirement paycheck (“LRP”)
  2. Flexible LRP start date
  3. Potential for increased LRP amount
  4. Ability to calculate an LRP amount that you will receive beginning on a specified future date on the date of purchase
  5. Ability to adjust initial and ongoing investment amount to match one’s income needs

A charge is deducted from the accumulation value of a FIA on a monthly, quarterly, or annual basis in exchange for the foregoing five features when they are provided by an optional income rider. It’s generally calculated as a percentage of the income account value, however, the charge is sometimes calculated as a percentage of the accumulation value. A typical charge ranges between 0.75% and 0.95% of the income account value.

The income account value is used to calculate the amount of your LRP and is separate and apart from the accumulation value of your annuity contract. The starting point for the calculation is your initial and ongoing investments plus any premium bonuses offered by the life insurance company. A simple or compound growth factor is applied to the income account value for a specified number of contract years or until income withdrawals begin, whichever occurs first.

As an example, let’s say that you invest $100,000 in a FIA with an income rider that uses 6% annual compound growth for the first 12 years of the contract to calculate the income account value in exchange for an income rider charge of 0.95% of the income account value that’s deducted from the accumulation value. At the end of year 1, your income value is $106,000 ($100,000 x 1.06). An income rider charge of $1,007 ($106,000 x 0.95) will be deducted from your accumulation value. At the end of year 2, your income value is $112,360 ($106,000 x 1.06). An income rider charge of $1,067 ($112,360 x 0.95) will be deducted from your accumulation value.

The income account value will continue to increase by the 6% compound growth factor for 12 years in this example, assuming income withdrawals aren’t taken in the first 12 years. Consequently, the income rider charge will also increase for the first 12 years of the contract before it levels off and begins decreasing when income withdrawals begin.

Is the income rider charge worth it? Find out in Part 2 next week.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 2 of 2

Part 1 of this post made the point that if your goal is to receive sustainable lifetime income, in addition to Social Security, fixed income annuities offered by life insurance companies will meet your need. Please read Part 1 to learn about the three types of fixed income annuities, including each one’s income start date.

If you’re seeking total flexibility for your lifetime income start date, then a fixed index annuity (“FIA”) with an optional income rider is your best bet. Unlike single premium immediate annuities (“SPIA’s”) and deferred income annuities (“DIA’s”) where the sole purpose is to provide sustainable income, a FIA can fulfill multiple financial needs, a discussion of which is beyond the scope of this post. When you purchase a FIA, assuming your goal is sustainable lifetime income, you must purchase an optional income rider with an annual income rider fee.

Unlike the start date for SPIA’s and DIA’s which is contractually defined, it is much more flexible with FIA’s. Most FIA income riders, also known as guaranteed minimum withdrawal benefit (“GMWB”) riders, have two requirements when it comes to the income start date:

  1. You must wait at least one year after the contract is issued, and
  2. You must be at least age 50.

Assuming that you meet both requirements, the age at which you begin taking income withdrawals from a FIA is up to you. Unlike Social Security which has an eight-year window for choosing your income start date, i.e., between age 62 and 70, the start date with FIA’s is open-ended once the two requirements have been met.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Unlike Social Security where your benefit amount will increase 7% – 8% each year that you defer your start date, the amount of increase is defined by the income rider provision of each FIA’s contract. Also, unlike Social Security, the percentage increase is generally significantly greater when you cross five-year milestones, e.g., age 60, 65, 70, 75, etc.

Here’s an example from a recent case for one of my clients who are currently in their early to mid 50’s and have invested approximately $250,000 in a FIA with an income rider. If they begin taking income at the younger spouse’s age 63, they will receive annual lifetime income of $20,479. At age 64, the amount increases 6% to $21,708. If they wait until age 65, it increases 19.3% from their age 64 amount to $25,886.

With a FIA with an income rider, in addition to having the security of receiving sustainable lifetime income, you have the luxury of starting your income when you need it. This is in addition to several other benefits offered by FIA’s, a discussion of which has been presented in various Retirement Income Visions™ posts.