Tag: compound interest

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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.

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Annuities Fixed Index Annuities

When Should You Begin Investing in Income Rider Fixed Index Annuities?

Retirement Income Center - Runners

The last two posts, When Should You Begin Your Lifetime Retirement Payout? – Parts 1 and 2, analyzed the different possibilities for timing of commencement of income withdrawals from a fixed index annuity (“FIA”), assuming that you purchase an income rider. As discussed, while the timing should be targeted when designing a retirement income plan before any FIA’s are purchased, the income withdrawal starting date is open-ended. As a matter of fact, as pointed out in Part 2, there’s no requirement to ever exercise your income rider.

Let’s take a look at the front end of the retirement income planning timing decision. Assuming that your primary reason for purchasing one or more FIA’s is to provide you, and your spouse or significant other if applicable, with guaranteed (subject to the claims-paying ability of individual life insurance companies) predictable lifetime income with a flexible starting date, and further assuming that you purchase an optional income rider, when should you begin investing in FIA’s?

Before answering this question, it should be emphasized that investment in a particular FIA doesn’t have to be a one-time transaction. There are two types of FIA’s – single premium deferred annuities, or “SPDA’s,” and flexible premium deferred annuities, or “FPDA’s,” with the latter permitting multiple investments. Of the 256 FIA’s on the market today, 171, or 66.8%, can be coupled with guaranteed minimum withdrawal benefits (“GMWB’s”), or income riders. Of the 171 GLWB FIA’s, 110, or 64.3%, are FPDA’s. How’s that for alphabet soup?

Whether making a one-time investment using a SPDA or FPDA, or multiple investments in a FPDA, in order to take advantage of the magic of FIA income riders, the one-time or initial investment, assuming it’s the largest investment, should be made a minimum of five years, and preferably ten to twenty years, before the income withdrawal starting date.

If you read the April 2, 2012 post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, you know that there are six potential variables that are used in the calculation of the income account value that’s used to determine the amount of income that you will receive from a particular FIA. In addition to the initial and subsequent investment amounts, potential premium bonuses, interest rate and interest crediting method, i.e., simple or compound, one of the key variables is the interest period.

The interest period, or accumulation phase, as it’s otherwise known, is a finite period of time, with one, or a combination of, three possibilities: (a) until income is started, (b) specified number of years, or (c) specified age. The longer the interest period, the greater your income account value will be. For riders that use a specified number of years, ten is common, although it can be as long as twenty.

Assuming an investment of $100,000 in a FIA with an income rider that offers 6% compounding for 15 years, the income account value will grow to $126,248 in five years, or $226,090 in 15 years, or approximately $100,000 greater if the investment was made ten years sooner. Assuming the individual is 65 when both values are reached, he/she wants to begin income withdrawals, and the contract provides for a 5% withdrawal rate, the annual withdrawal, or lifetime retirement payments (“LRP”), will be $6,312 ($126,248 x 5%) in the first case, or $11,305 ($226,090 x 5%), or almost $5,000 greater, in the second case where the initial investment was made ten years sooner.

In summary, the earlier that you begin investing in fixed index annuities relative to the projected year that you will need to begin taking income withdrawals to meet the projected income shortfall in your retirement income plan, the more time your FIA income rider will have to work its magic, and the greater your lifetime income will be.

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Annuities Fixed Index Annuities

Don’t Be Fooled by Interest Rates – It’s a Package Deal – Part 1 of 2

Retirement Income Center - Mover

If you’ve read the last two posts, How is Your Fixed Index Annuity’s Income Account Value Calculated? and How Much Income Will You Receive From Your Fixed Index Annuity?, you know that there are several variables that come into play when calculating the amount of lifetime income you will receive from a fixed index annuity (FIA) with an optional income rider when you begin taking income withdrawals. One variable that receives a disproportionate amount of attention, in my opinion, is the interest, or “roll up” rate.

With fixed income investments, a natural question is, “What is the rate of return?” This is an easy question to answer with straightforward fixed income investments such as CD’s where there’s a stated rate of return for a fixed period of time, e.g., six months, one year, etc. It’s important to understand that a FIA interest, or “roll up” rate, as it is sometimes referred, unlike traditional fixed income investments, isn’t the rate of return on a FIA.

As explained in the April 2, 2012 post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, the interest rate is one of six potential variables that’s applied to initial and subsequent investments and premium bonus amounts on an annual basis to calculate the income account value of a FIA.

As discussed in the April 9, 2012 post, How Much Income Will You Received From Your Fixed Index Annuity?, you need to apply either a single or joint annuitant withdrawal percentage from your FIA’s table of maximum annual lifetime income withdrawal percentages to the income account value for the age at which you plan on beginning your income withdrawals to determine the amount of annual lifetime income you will receive.

Since it is only one of several variables that will ultimately determine the amount of income that you will receive from your FIA, interest rates shouldn’t be relied upon to determine which FIA will produce the greatest amount of income in a particular situation. A FIA may have a high interest rate, however, if the interest method is simple vs. compound, the interest period is short, and/or the withdrawal rate at a particular age is less than that of another FIA, then the lifetime income may not be as much as another product with a more favorable combination of income calculation variables.

Part 2 will discuss the two most important factors for calculating FIA income withdrawal amounts and will include an illustration to show why interest rates shouldn’t drive your decision regarding the fixed index annuity that will provide you with the greatest amount of lifetime income.

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Annuities Fixed Index Annuities

How is Your Fixed Index Annuity’s Income Account Value Calculated?

Retirement Income Center

As stated in several blog posts, as a general rule, in order to receive income from a fixed index annuity (FIA), you need to purchase an optional income rider when you apply for a FIA. Assuming that you do this, in addition to your contract having an accumulation value, or the value of your investment before any applicable surrender charges, it will also have an income account value.

Per the March 19, 2012 post, Income Account Value vs. Accumulation Value – What’s the Difference?, your fixed index annuity contract’s income account value will be used to determine the amount of income that you will receive each year once you begin to take your income distributions. Unlike accumulation value, the amount of which is generally readily available on your FIA’s life insurance company website and is also included on your FIA’s annual statement, other than appearing on an initial sales illustration, income account value is generally a “behind-the-scenes” calculation.

How is income account value calculated? There are six potential variables as follows:

  1. Initial and subsequent investment amounts
  2. Premium bonus amounts
  3. Interest rate
  4. Interest crediting method
  5. Interest period
  6. Optional interest period

Initial and Subsequent Investment Amounts

The amount of your initial and subsequent investments in your FIA will be the single most important factor for determining your income account value. The larger your investment, the greater your income account value.

Premium Bonus Amounts

Per the February 6, 2012 post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses, a premium bonus is a fixed percentage of the investment in a FIA that’s added by some life insurance companies to the FIA’s accumulation value of specified products. Premium bonuses are paid on investments during the first contract year and can also be paid on subsequent years’ investments for a specified number of years, depending on the particular FIA. To the extent that a premium bonus is available, it will be added to investment amounts to calculate income account value.

Interest Rate

The interest rate, or “roll up” rate as it is sometimes referred, is a fixed rate that’s applied to initial and subsequent investments and premium bonus amounts on annual basis. For the income riders offered by my life insurance agency, the interest rate currently varies between 4.5% and 8%.

Interest Crediting Method

As important as the interest rate is the interest crediting method. There are two types of interest crediting methods that are used to calculate income account value: (1) simple and (2) compound. All else being equal, 8% simple crediting may not result in a greater income account value than 6.5% compound crediting depending upon the number of years in the accumulation phase and the interest period.

Interest Period

Whether simple or compound, the stated interest rate will be applied annually for a specified period of time. There are three possibilities as follows:

  1. Until income is started
  2. Specified number of years
  3. Specified age

Several income riders use a specified number of years which is typically 10. Other income riders use a combination of variables, e.g., until income is started or age 90, earlier of age 90 or 20 contract years, etc.

Optional Interest Period

Some income riders have a provision for an additional interest period once the standard interest period runs its course assuming income withdrawals haven’t been taken yet. A life insurance company may reserve the right to increase the income rider cost if the optional interest period is exercised.

Next week’s post will include an example illustrating how income account value is calculated in order to enhance your understanding of this important concept.