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.
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.
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.