Tag: income account value

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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.

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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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Fixed Index Annuities Retirement Income Planning

Cap Rates Are Secondary When Optimizing Retirement Income

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If you’ve been reading Retirement Income Visions™ for any length of time, you know that I’m a fan of fixed index annuities (“FIA’s”) with income riders, or guaranteed minimum withdrawal benefit’s (“GMWB’s”) as part of a retirement income planning solution in the right situation. The ability to create a predictable retirement paycheck with a flexible start date that includes an investment component with upside potential, downside protection, and a potential death benefit is unparalleled in the investment and insurance world.

For you horse race fans, that’s what I call hitting the trifecta! Unlike horse race betting, when you invest in a FIA with an income rider with a highly-rated life insurance company, while the results aren’t guaranteed since they’re subject to the claims paying ability of each individual insurance carrier, your bet is pretty secure given the stellar historical claims paying experience of the life insurance industry.

It’s important to understand that very few FIA’s that are sold today include GMWB’s as part of their base product. If you need sustainable lifetime income beginning at a specific age, you will generally need to purchase an optional income rider when you complete your FIA application. Only about two-thirds of FIA’s on the market today offer an optional income rider. An income rider charge of between 0.75% and 0.95% of your contract’s income account value will generally be deducted from your contract’s accumulation value each year.

Assuming that your goal is to maximize sustainable lifetime income, once you, or more likely your retirement income planner, narrows your FIA search to those that include a GMWB or optional income rider, illustrations need to be prepared for multiple products offered by highly-rated life insurance companies that are well-established in the FIA business to determine which ones will provide you with the greatest amount of income for your desired investment amount(s) beginning at various ages.

This is a difficult task due to the fact that there are several variables that are used in the calculation of annual income that will be received from a particular FIA. After analyzing hundreds of FIA illustrations, trust me, it requires a lot of skill, hands-on experience, and access to dozens of options, including appointment as a licensed life insurance agent with multiple life insurance carriers, in order to offer an independent optimal recommendation for a particular situation. One product may provide greater income beginning at age 62, however, another one may be more suitable if you don’t plan on taking withdrawals until age 70.

What about cap rates? Assuming your goal isn’t to create a predictable retirement paycheck, there’s no need to purchase a FIA with a GMWB or income rider. If this is your situation, you should be paying close attention to the caps, or limits, on interest that will be credited to your account each year that are associated with various indexing methods offered by a particular FIA depending upon its performance during the previous contract year.

If, on the other hand, your primary goal is to optimize lifetime income beginning at a particular age, cap rates, while important, should be a secondary consideration when choosing a FIA. While higher cap rates may result in a greater accumulation value that may more seamlessly absorb income rider charges associated with good market performance and may potentially result in a greater death benefit, they generally won’t affect the amount of lifetime income that you will ultimately receive from a particular FIA. This is due to the fact that the lifetime income calculation of most FIA’s is generally independent of indexing method performance. Furthermore, even if there’s no remaining accumulation value in your contract as a result of income withdrawals over many years, you will continue to receive your income so long as you’re alive.

While cap rates are often hyped by life insurance companies when promoting FIA’s, they should be a secondary consideration when your primary goal is to create and optimize a predictable retirement paycheck beginning at a specific age. If this is your situation, you or your retirement income planner should be devoting the majority of your research to locating those FIA’s offered by highly-rated life insurance companies that are well-established in the FIA business that include a GMWB or income rider that will enable you to achieve your goal.

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Annuities Fixed Index Annuities

Fixed Index Annuities – A Long-Term Commitment

“I, Robert Klein, take you FIA, to be my Fixed Index Annuity, to have and to hold from this day forward, for better or for worse, for richer, for poorer, in sickness and in health, to love and to cherish; from this day forward until death do us part.”

While you don’t say a traditional wedding vow when you purchase a fixed index annuity (“FIA”), you do make a long-term commitment. This is especially true when you purchase a FIA with an income rider. Divorce is generally an expensive proposition. This applies to FIA’s as well.

In order to realize the benefits of fixed index annuities, including upside potential with downside protection (See the July 18, 2011 post, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities), you need to stay invested, i.e., not take withdrawals, for five to ten years, or potentially longer, depending on the particular FIA.

Of the 245 FIA’s available today, 147, or 60%, impose surrender charges for ten years or longer, with 182, or 74%, having surrender periods of eight years or longer. There are only two FIA’s that have a surrender period of less than five years, both for four years. Surrender charges are generally assessed using a declining schedule, with 148, or 60%, imposing a charge of 10% or more in the first year. Generally speaking, the more severe the surrender charge provision, the greater the potential benefits.

While most FIA’s allow you to withdraw up to 10% of the value of your contract in any year without a surrender charge, you shouldn’t plan on taking advantage of this provision when you purchase a FIA. You should only invest funds that you’re confident you won’t need for at least the duration of the surrender charge period. This assumes that you haven’t purchased an income rider.

When you purchase a FIA with an income rider, you extend your commitment – to life. In addition to the time period you must remain in any FIA to avoid potential surrender charges, plan on keeping your FIA for the duration of your life, and your spouse’s life, if married. You need to do this in order to optimize your return. Unlike most fixed income investments that have a fixed rate assigned to them, this isn’t the case when it comes to a FIA with an income rider.

Return on a FIA with an income rider is measured by the total amount of income withdrawals received over one’s lifetime. In order to maximize your lifetime income withdrawals, you need to generally do two things: (a) maximize your income account value in order to optimize your annual withdrawal amount (see the March 19, 2012 post, Income Account Value vs. Accumulation Value – What’s the Difference?) and (b) once you start your withdrawals, keep your FIA in place for the rest of your life.

FIA’s have unique features that can result in lifetime retirement income that exceeds that of other investments provided you have the staying power. Are you ready to make a long-term commitment? If so, say “I do.”

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Annuities Celebration Fixed Index Annuities Retirement Income Planning

Retirement Income Visions Celebrates 3-Year Anniversary!

Thanks to my clients, subscribers, and other readers, Retirement Income Visions™ is celebrating its three-year anniversary. Retirement Income Visions™ has published a weekly post each Monday morning, the theme of which is Innovative Strategies for Creating and Optimizing Retirement Income™.

As stated in the initial post on August 16, 2009, Retirement Income Visions™ Makes Its Debut, the importance of retirement income planning as a separate and distinct discipline from traditional retirement planning was magnified during the October, 2007 – March, 2009 stock market decline. Just ask anyone who retired just prior to, or during, this period that didn’t have a retirement income plan in place when he/she retired.

With increasing life expectancies, record-low interest rates, traditional pension plans going by the wayside, soaring health and long-term care costs, and the potential for inflation, retirement income planning is no longer an option. It has become a necessity for anyone who wants to ensure that he/she will have sufficient income to meet his/her expenses for the duration of retirement. Recognizing this fact, The American College launched its Retirement Income Certified Professional™ (RICP™) program earlier this year in which I was one of the first enrollees.

Since its inception, Retirement Income Visions™ has used a themed approach, with several weeks of posts focusing on a relevant retirement income planning strategy. This year was no exception. The weekly posts, together with the customized Glossary of Terms, which currently includes definitions of 137 terms to assist in the understanding of technical subject matter, has contributed to a growing body of knowledge in the relatively new retirement income planning profession.

While the first two years of Retirement Income Visions™ presented a variety of retirement income planning strategies, fixed index annuities, or “FIA’s,” have been the sole focus of virtually every weekly post for the past 13 months. Continuing a theme that began on July 11, 2011 during the second year of publication with Shelter a Portion of Your Portfolio From the Next Stock Market Freefall, the inner workings of FIA’s, including their unique benefits as a retirement income planning solution, has been discussed in detail. As a result, Retirement Income Visions™ has become an authoritative source of information on this important and timely topic.

Although FIA’s has been the theme of almost every post for over a year, the posts have been organized by a number of sub-themes. Following the July 11, 2011 post, the introduction to the FIA strategy continued with the next five posts, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities (July 18, 2011), Limit Your Losses to Zero (July 25, 2011), Do You Want to Limit Your Potential Gains? (August 1, 2011), When is the Best Time to Invest in Indexed Annuities? (August 8, 2011), and How Does Your Fixed Index Annuity Grow? (August 22, 2011).

The next twelve posts, beginning with the August 29, 2011 post, Indexing Strategies – The Key to Fixed Index Annuity Growth, through the November 14, 2011 post, How to Get Interest Credited to Your Fixed Index Annuity When the Market Declines, presented a thorough discussion of the various traditional fixed index annuity indexing strategies. This included an introduction to, and comparison of, the following indexing methods: annual point-to-point, monthly point-to-point, monthly average, trigger indexing, inverse performance trigger indexing, as well as the fixed account that’s included as one of the strategy choices by virtually every FIA.

Moving beyond the base product, the subject of the next nine posts was an introduction to the income rider that’s offered by many FIA’s. The income, or guaranteed minimum withdrawal benefit (“GMWB”), rider is the mechanism for providing guaranteed (subject to the claims-paying ability of individual life insurance companies) lifetime income with a flexible start date that is essential to so many retirement income plans. This kicked off with the enlightening December 5, 2011 and December 12, 2011 posts, No Pension? Create Your Own and Add an Income Rider to Your Fixed Index Annuity to Create a Retirement Paycheck. The introduction to income rider series also included two two-part series, Your Fixed Index Annuity Income Rider – What You Don’t Receive (December 19, 2011 and December 26, 2011) and 5 Things You Receive From a Fixed Index Annuity Income Rider (January 9, 2012 and January 16, 2012).

Following two posts introducing fixed index annuity income calculation variables on January 23, 2012 and January 30, 2012 (10 Fixed Index Annuity Income Calculation Variables and Contractual vs. Situation Fixed Index Annuity Income Calculation Variables), a five-part series ensued revolving around a topic often misunderstood by the general public — premium bonuses. The posts in this series included 8 Questions to Ask Yourself When Analyzing Premium Bonuses (February 6, 2012), What’s a Reasonable Premium Bonus Percentage? (February 13, 2012), How Will a Premium Bonus Affect a Fixed Index Annuity’s Value? (February 20, 2012), How Will Withdrawals Affect Your Premium Bonus? (February 27, 2012), and How Will a Premium Bonus Affect Your Fixed Index Annuity Income Distribution? (March 5, 2012).

The next five posts delved into the inner workings behind the variables and interaction of variables behind the calculation of income withdrawal amounts from FIA income riders. This included the following posts: Income Account Value vs. Accumulation Value – What’s the Difference? (March 19, 2012), How is Your Fixed Index Annuity’s Income Account Value Calculated? (April 2, 2012), How Much Income Will You Receive From Your Fixed Index Annuity? (April 9, 2012), and a two-part series, Don’t Be Fooled by Interest Rates – It’s a Package Deal (April 16, 2012 and April 23, 2012).

When Should You Begin Your Lifetime Retirement Payout? was the subject of a two-part series (May 7, 2012 and May 14, 2012) followed by another timing question, When Should You Begin Investing in Income Rider Fixed Index Annuities? (May 21, 2012).

The May 28, 2012 through June 18, 2012 four-part series, Fixed Index Annuity Income Rider Similarities to Social Security, was a well-received and timely topic. This was followed by a second five-part comparison series beginning on June 25, 2012 and continuing through July 23, 2012, FIA’s With Income Riders vs. DIA’s: Which is Right for You?

The last two weeks’ posts have addressed the topic of valuation of a FIA’s income rider stream. This included the July 30, 2012 post, What is the Real Value of Your Fixed Index Annuity, and the August 6, 2012 post, Why Isn’t the Value of Your Income Stream Shown on Your Fixed Index Annuity Statement?.

As I did in my August 9, 2010 and August 15, 2011 “anniversary” posts, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback and inspiration. Last, but not least, thank you to Nira, my incredible wife, for her enduring support of my blog writing and other professional activities.

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Annuities Fixed Index Annuities

Why Isn’t the Value of Your Income Stream Shown on Your Fixed Index Annuity Statement?

Last week’s post made the point that, in addition to the accumulation value of a fixed index annuity (“FIA”), there’s a value that can be calculated and attached to the future income stream from an income rider. Furthermore, unlike the accumulation value of your FIA that will change over time, unless you make additional investments or take non-income withdrawals, the amount of your lifetime income withdrawals are predetermined and are contractually guaranteed.

So if the amounts of lifetime income withdrawals are known at the time of purchase of your FIA, why don’t life insurance companies show the present value of the withdrawals on annual statements? The reason it’s not done is because there are several unknowns throughout the life of the contract that can affect the amount and duration of the income payout. There are two types of unknowns:  amount and duration variables.

Amount Variables

There are two variables that can increase or decrease the lifetime retirement payments (“LRP”) from an FIA:

  1. Additional investments
  2. Non-income withdrawals

Additional investments will increase LRP’s while non-income withdrawals will decrease LRP’s. In addition, the timing of additional investments and non-income withdrawals relative to the issue date will directly affect the LRP amount.

Additional Investments

Generally speaking, the sooner that additional funds are added to an existing FIA contract, the larger the income payout. This can happen in two different ways as follows:

  1. The sooner additional investments are made, the more time there is for the funds to increase the income account value and the ultimate LRP.
  2. To the extent that the FIA offers a premium bonus and the premium bonus provision applies to additional investments, this will also increase the income account value and LRP.

Non-Income Withdrawals

Timing of non-income withdrawals will also affect the LRP amount. This can happen in three different ways as follows:

  1. The sooner that the withdrawals occur, there will be a reduced income account value growing for a longer period of time.
  2. The sooner withdrawals occur, the greater the surrender charge which will increase the withdrawal amount and decrease the income account value and LRP.
  3. To the extent that a premium bonus has been paid, non-income withdrawals will result in a recapture of part, or all, of the premium bonus if they occur during a stated period of time, generally the first ten years of the contract, which will in turn reduce the income account value and LRP.

Duration Variables

Let’s assume that your FIA will never have any additional investment or non-income withdrawal transactions. In this case, the LRP’s will be the amounts beginning at different ages per the illustration that was prepared for you when you purchased your FIA. Why doesn’t your FIA statement show the present value of your LRP in this situation?

The answer is unknown duration. While the LRP amount is known, its duration isn’t. FIA income withdrawal amounts are paid for life and no one knows when you’re going to die. If you’re married, payments are made for the duration of the lives of both spouses and no one knows when the surviving spouse will die.

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Annuities Fixed Index Annuities

Fixed Index Annuity Income Rider Similarities to Social Security – Part 1 of 4

Retirement Income Center - Currency

As evidenced by the number of blog posts regarding fixed index annuity (“FIA”) income riders beginning with the December 12, 2011 post, Add an Income Rider to Your Fixed Index Annuity to Create a Retirement Paycheck, there are a lot of things to consider before adding this powerful optional benefit to a FIA.

It isn’t easy to determine which fixed index annuity income rider will produce the optimal amount of lifetime income in a given situation. This task is best left to an experienced retirement income planner who not only works routinely with this and other retirement income planning vehicles, but more importantly, understands you, your retirement income planning needs, and your overall financial situation.

As a potential purchaser of a FIA with an income rider, the easiest way to begin to understand a fixed index annuity income rider is to compare and contrast this retirement income planning strategy with Social Security retirement benefits. There are eight characteristics shared by FIA income riders and Social Security as follows:

  1. Lifetime income
  2. Entry fee
  3. Flexible income start date
  4. Increased annual lifetime income
  5. Inflation and longevity risk protection
  6. Income ceiling
  7. Portfolio risk reduction
  8. Income taxation

This post will discuss the first two, with three through five addressed in Part 2, six and seven covered in Part 3, and income taxation reserved for Part 4.

Lifetime Income

Both Social Security and FIA income riders are designed to provide their intended recipients with lifetime income. By their nature, the investment return and overall investment value of both income vehicles is open-ended and cannot be determined until the death of the recipient, and in many cases, a spouse, if married.

The income in both cases is generally considered to be guaranteed, however, the nature of the guarantee is different in each case. Although the resources backing the Social Security system are projected to be sufficient to sustain current benefit formula payments for approximately the next 20 to 30 years, there is a strong possibility that the projected increasing ratio of number of retirees to employees will necessitate a reduction in benefit levels at some point. Although the security of annuitization and income rider payments enjoy a superb historical track record, the income rider lifetime guarantee is subject to the claims-paying ability of individual life insurance companies.

Entry Fee

In order to obtain the lifetime income benefit associated with FIA income riders and Social Security, there’s an entry fee. The amount of the fee in both cases is calculated as a percentage of a predefined base and is generally, although not always in the case of Social Security, automatically deducted from the applicable funding source.

For employees, the Social Security entry fee is currently 4.2% of Social Security earnings up to a maximum of $110,100 in 2012. The calculated amount is automatically deducted from an employee’s gross salary. In addition, employers are required to pay a rate of 6.2% on the same earnings level. For self-employed individuals, the rate is 10.4% of net self-employment earnings and is typically paid, together with medicare tax and projected income tax liability, via estimated tax payments.

The entry fee for a FIA income rider is deducted from the FIA’s accumulation value. It’s calculated as either a percentage of the accumulation value or income account value, with the latter being the most prevalent. Of the 171 FIA’s offering guaranteed minimum withdrawal benefits (“GMWB’s”), or income riders, on the market today, 121, or approximately 70%, use the income account value as the basis for charging the income rider charge. 90 of the 121, or approximately 75%, charge up to 0.75% of income account value, with 52 of the 90, or 58%, falling between 0.50% and 0.75%.

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Annuities Fixed Index Annuities

When Should You Begin Your Lifetime Retirement Payout? Part 1 of 2

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When you purchase a fixed index annuity (“FIA”) with an income rider, in addition to having an accumulation value that’s standard with every FIA, you purchase the right to receive a future lifetime income stream, or lifetime retirement payments (“LRP’s”). The income stream is payable over your life and potentially that of a spouse or other joint annuitant if applicable.

Although you’re not required to exercise the income rider, it behooves you to do so since there’s generally a cost associated with the rider. The income rider charge is deducted from the contract’s accumulation value. It’s calculated as either a percentage of the accumulation value or the income account value, sometimes referred to as the guaranteed minimum withdrawal benefit, or “GMWB,” with the calculation based on income account value for most riders.

When should you exercise your income rider and begin your lifetime retirement payout? In order to answer this question, you first need to know when your income rider allows you to start taking income withdrawals. Generally speaking, income riders allow you to begin taking income withdrawals either during the initial contract year or after the first contract year. In addition, most contracts won’t let you start withdrawing income until you attain a specific age, typically 50.

Assuming that the provisions of your income rider allow you to begin your income stream during or after the first contract year, should you turn on your LRP right away? Generally speaking, this isn’t a good strategy. Similar to Social Security where you have the right to receive benefits beginning at age 62, unless you have no other source of income, it generally doesn’t make sense to do so.

With both Social Security and FIA income riders, the longer you defer your income start date, the greater your income will be. Unlike Social Security benefits which max out at age 70 excluding cost of living increases, as a general rule, FIA income rider beginning withdrawal amounts continue to increase well beyond age 70.

The LRP increase amount is dependent upon two factors: (1) Number of years remaining in the accumulation phase of the income account value and (2) Age at which withdrawal percentages no longer increase. Once the income account accumulation phase ends, LRP increases will generally occur every five years since the withdrawal percentages of most income riders are based on five-year age bands, e.g. 75 – 79, 80 – 84, etc. The final age band of some income riders is 80+ up to 95-99 for one of the income riders available through my life insurance agency.

Even though the beginning LRP continues to grow until age 80 or beyond, should you wait this long to exercise your income rider? In most situations, the answer is often “no,” however, if you purchased your FIA at an advanced age, say 70 or older, it will generally behoove you to defer your income start date in order to complete your income account value accumulation phase and, in the process, optimize your benefit amount, assuming you’re in good health. As discussed in the April 2, 2012 post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, if income hasn’t been started, the interest period of the accumulation phase is generally a certain number of years, typically ten, although it can be limited by a specified age, e.g., 85 or 90.

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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 Much Income Will You Receive From Your Fixed Index Annuity?

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Assuming that you purchase an optional income rider when you apply for a fixed index annuity (FIA), do you know how much income you will receive from your FIA when you begin taking your income withdrawals? The benefit of investing in a deferred income annuity, including a FIA with an income rider, vs. other types of investments, is the security of receiving a known, predictable income stream beginning at a specified future date payable for a specified number of years or potentially for life, depending on the product. In the case of a FIA, the payment is always for life.

After reiterating the point from a previous post that your FIA 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, last week’s post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, presented six potential variables that are used to calculate a FIA’s income account value. Once this is done, there is one final step required for calculating the amount of income that you will receive from your FIA.

In every FIA contract that includes an income rider that ties its income calculation to a contract’s income account value, you will find a table of maximum annual lifetime income withdrawal percentages, or lifetime payment percentages, for single and joint annuitants for different age brackets. The age brackets are generally for five-year periods of time beginning at age 50.

Annual income is determined by applying either the single or joint annuitant withdrawal percentage, as applicable, for the age at which you plan on beginning your income withdrawals to your income account value at your targeted withdrawal commencement age. In the case of joint annuitants, the younger individual’s age is always used.

As an example, suppose your husband, age 55 and you, age 52, invest $100,000 in a non-premium bonus FIA with an income rider that includes the following three contractual variables:

  1. Interest rate: 7%
  2. Interest crediting method: Compound
  3. Interest period: First ten contract years

Let’s further assume that both of you are working and you will both retire at age 65 and will begin taking lifetime income withdrawals from your FIA at your husband’s age 70 and your age 67. How much annual lifetime income will you receive from your FIA when you begin taking your withdrawals?

Per Exhibit 1, your income account value, the initial value of which is $100,000 when you make your investment at your age 52, grows at an annual 7% compound rate for the first ten contract years. Your income account value reaches its maximum level of $196,715 at age 62 and remains at that level until your husband and you begin taking your lifetime income distributions.

In order to determine the annual amount of lifetime income that you will receive beginning at your husband’s age 70 and your age 67, you need to apply a lifetime payment percentage from your FIA contract’s lifetime payment percentage table to your income account value. Per Exhibit 2, at age 67, the younger of your two ages, the applicable percentage is 4.50%. Applying this percentage to your income account value of $196,715 results in annual lifetime income of $8,852, or 8.8% of your initial investment of $100,000.

If you wait three additional years until your age 70 to begin taking lifetime income withdrawals, your annual lifetime payment would increase by $492 to $9,344 ($196,715 x 4.75%), or 9.3% of your initial investment of $100,000. If you invested $200,000 instead of $100,000 at age 52, your annual lifetime payment would be double this amount, or $18,688.

Is the security of receiving a known, predictable income stream beginning at a specified future date payable for life important to you? If so, you may want to consider investing a portion of your assets in a fixed index annuity with an income rider.

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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.

Categories
Annuities Fixed Index Annuities

Income Account Value vs. Accumulation Value – What’s the Difference?

Retirement Income Center

The March 5, 2012 post, How Will a Premium Bonus Affect Your Fixed Index Annuity Income Distribution?, answered the eighth and final question presented in the February 6, 2012 post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses. Taking a further step back, premium bonus availability was the first fixed index annuity variable included in the list of six contractual variables introduced in the January 30, 2012 post, Contractual vs. Situational Fixed Index Annuity Income Calculation Variables.

As stated in the January 30th post, there are six contractual and four situational variables, for a total of ten potential variables that are used to calculate the income, or lifetime retirement paycheck (“LRP”) amount that you will receive when you purchase an income rider with your fixed index annuity (“FIA”). Before continuing our discussion of the remaining six contractual variables, it’s important that you understand the concept of “income account value,” and how it differs from “accumulation value.”

When you purchase a FIA, the accumulation value is the value of your investment before any applicable surrender charges. This is the amount that you or your beneficiaries will receive if you terminate, or surrender, your FIA or if you die, assuming that your contract’s accumulation value is greater than its guaranteed minimum value.

If you opt for an income rider when you purchase a FIA, and assuming that you will exercise your rider by taking income withdrawals from your FIA, your contract’s income account value will determine the amount of income that you will receive each year once you begin to take your income distributions. With an income rider, you, and if applicable, a joint annuitant, are entitled to receive income for the rest of your life, or lives.

Any income withdrawals will reduce the accumulation value of your FIA, with any remaining value payable to your contract’s beneficiaries in the event of your, and your joint annuitant’s, if applicable, death(s). Assuming that income withdrawals continue for several years, it’s possible that your accumulation value will be depleted while you or a surviving joint annuitant continue(s) to receive income.

How is a FIA’s income account value calculated? Stay tuned for next week’s post.

Categories
Annuities Fixed Index Annuities

Contractual vs. Situational Fixed Index Annuity Income Calculation Variables

Retirement Income Center

Last week’s post, 10 Fixed Index Annuity Income Calculation Variables, introduced ten potential variables that are used to calculate the income, or lifetime retirement paycheck (“LRP”), amount that you will receive when you purchase an income rider with your fixed index annuity (“FIA”).

It’s important to emphasize that all ten variables won’t apply in every situation. Six are contract-dependent and four are situational. Situational variables, by their nature, occur after the fact, and, as such, often cannot be anticipated when deciding which FIA(s) to purchase. Having said this, each variable needs to be taken into consideration by a retirement income planner when analyzing and selecting FIA income riders and products that may be appropriate for a particular situation.

Contractual Variables

Contractual variables are addressed in various sections of a FIA contract. The six contractual variables are as follows:

  1. Premium bonus availability
  2. Income account value interest rate
  3. Number of years income account value interest rate is in effect
  4. Maximum lifetime income withdrawal percentage
  5. Surrender charge schedule
  6. Premium bonus recapture provision

Variables #1 and #6, premium bonus availability and premium bonus recapture provision, are directly related. When offered, premium bonus provisions appear in the base contract since they affect the accumulation value regardless of whether an income rider is also purchased. Variable #5, surrender charge schedule, is also included in the base contract. Variables #2 – #4 are only applicable to income riders, and, as such, will be included in the income rider section of a FIA contract.

Situational Variables

Situational variables, although they will trigger one or more contractual provisions, arise as a result of an action on the part of the contract owner. The four situational variables are as follows:

  1. Initial and subsequent investment amounts
  2. Lifetime payment election date
  3. Accumulation value withdrawal amounts and timing of same
  4. Death of owner prior to commencement of income payments

The first three situational variables are controllable by the contract owner while variable #4, death of the owner prior to commencement of income payments, is unpredictable. Variables #1, #3, and #4 affect both the accumulation value and the income rider payout. Variable #2, lifetime payment election date, is unique to the income rider.

Now that we have made the distinction between contractual vs. situational fixed index annuity income calculation variables, we will continue our exploration of each of these variables in the next several posts, beginning with contractual variables.

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Annuities Fixed Index Annuities

10 Fixed Index Annuity Income Calculation Variables

Retirement Income Center

The last five weeks’ posts have focused on what you don’t receive (Your Fixed Index Annuity Income Rider – What You Don’t Receive – Parts 1 and 2 and Annuitization Tax Treatment of Nonretirement Distributions) and what you do receive (5 Things You Receive From a Fixed Index Annuity Income Rider – Parts 1 and 2) when you purchase a fixed index annuity income rider.

As stated in Part 1 of 5 Things You Receive From a Fixed Index Annuity Income Rider, there are three types of fixed income annuities that offer lifetime income payments: (a) single-premium immediate annuities, or “SPIA’s,” (b) deferred income annuities, or “DIA’s,” and (c) fixed index annuities, or “FIA’s.”

Per Part 2 of the same post, product-specific illustration software must be used to determine the periodic payment that you will receive from SPIA’s and DIA’s given certain specified assumptions. The reason for this is that the payment from both of these types of fixed income annuities is an annuity that must be actuarially calculated using a life expectancy factor amongst other variables.

The lifetime payment that you receive from a FIA, unlike a SPIA or DIA, isn’t an annuity that’s actuarially determined. In order to receive a FIA lifetime payment, you must purchase an income rider which is a separate component of a FIA contract. While it’s possible to annuitize the accumulation value of the base contract, distributions from the income rider are considered to be withdrawals.

So how are FIA income amounts determined? In addition to the accumulation value of a FIA which is the value of your investment before reduction for potential surrender charges, there’s generally a separate income account value when you purchase a FIA income rider. Unlike the accumulation value, withdrawals cannot be made from the income account value. The latter is used instead to determine your FIA income, or lifetime retirement paycheck (“LRP”) amount.

There are ten potential variables that are used to calculate the FIA income amount as follows:

  1. Initial and subsequent investment amounts
  2. Premium bonus availability
  3. Income account value interest rate
  4. Number of years income account value interest rate is in effect
  5. Lifetime payment election date
  6. Maximum lifetime income withdrawal percentage
  7. Accumulation value withdrawal amounts and timing of same
  8. Surrender charge schedule
  9. Premium bonus recapture provision
  10. Death of owner prior to commencement of income payments

In order to help you understand how a FIA income amount is calculated, FIA income calculation variables will be the topic of Retirement Income Visions™ posts for the next several weeks.