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:
- Guaranteed, subject to individual life insurance company claims-paying abilities, lifetime income or lifetime retirement paycheck (“LRP”)
- Flexible LRP start date
- Potential for increased LRP amount
- Ability to calculate an LRP amount that you will receive beginning on a specified future date on the date of purchase
- 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.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.