Tag: premium bonus

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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.

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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 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 Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4

The first three posts in this series discussed five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. If you haven’t done so already, I would recommend that you read each of these posts.

This week’s post presents a sample case to illustrate the use of a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement.

Assumptions

As with all financial illustrations, assumptions are key. A change in any single assumption will affect the results. The following is a list of assumptions used in the sample case:

  1. 55-year old, single individual
  2. Planned retirement start age of 68
  3. Life expectancy to age 90
  4. Current annual LTCI premium of $4,000 payable for life
  5. Need to plan for infrequent, although potentially double-digit percentage increases in LTCI premium at unknown points in time
  6. Given assumptions #4 and #5, plan for annual pre-tax income withdrawals of approximately $6,000 beginning at retirement age
  7. Solve for single lump sum investment at age 55 that will provide needed income
  8. Investment will come from a nonqualified, i.e., nonretirement, investment account
  9. One investment option is a fixed index annuity (“FIA”) with an income rider with lifetime income withdrawals beginning at age 68.
  10. Second investment option is a deferred income annuity (“DIA”) with no death benefit and lifetime income payout beginning at age 68.
  11. FIA premium bonus of 10%
  12. FIA annual return of 3%
  13. FIA income rider charge of 0.95% of income rider value otherwise known as the guaranteed minimum withdrawal benefit (“GMWB”)
  14. No withdrawals are taken from the FIA other than the income withdrawals.
  15. All investments are purchased from highly-rated life insurance companies known for providing innovative and competitive retirement income planning solutions.

Investment Amount

The first thing that needs to be solved for is the amount of investment that must be made at the individual’s age 55 in order to produce lifetime annual income of approximately $6,000 beginning at age 68. The goal is to minimize the amount of funds needed for the investment while choosing a strategy from a highly-rated insurance company that’s known for providing innovative and competitive retirement income planning solutions.

It turns out that an investment of $50,000 to $65,000 is needed to produce lifetime annual income of approximately $6,000 beginning at age 68. Given the fact that my goal as a retirement income planner is to use the smallest amount of investment for a fixed income annuity to produce a targeted income stream in order to preserve the remainder of a client’s investment portfolio for my client’s other financial goals, the amount of the investment needed is $50,000.

Results

There are three items we will examine to compare the results between investing $50,000 in a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement. They are as follows:

  • Annual gross income
  • Annual taxable income
  • Value/death benefit

Annual Gross Income

Per the Exhibit, the annual payout, or gross income, from the FIA is $5,764, or $236 less than the annual gross income of $6,000 from the DIA. This equates to a total of $5,428 for the 23 years of payouts from age 68 through age 90.

Annual Taxable Income

If the investment was made in a retirement account like a traditional IRA and assuming there have been no nondeductible contributions made to the IRA, 100% of the income would be taxable. This would be the case for both the FIA or DIA.

As stated in assumption #8, the investment will come from a nonqualified, i.e., nonretirement, investment account. Per Part 2 of this series, this makes a difference when it comes to taxation of the withdrawals. Per the Exhibit, 100% of the annual FIA income of $5,764 is fully taxable vs. $3,066 of the DIA income. This is because the DIA, unlike the FIA, is being annuitized and approximately 50% of each income payment is nontaxable as a return of principal. Over the course of 23 years of payouts, this results in $62,054 of additional taxable income for the FIA vs. the DIA.

The amount of income tax liability resulting from the additional taxable income from the FIA will be dependent upon several factors that will vary each year, including (a) types, and amounts, of other income, (b) amount of Social Security income, (c) potential losses, (d) adjusted gross income, (e) itemized deductions, (f) marginal tax bracket, and (g) applicable state income tax law.

Value/Death Benefit

While the present value of the future income stream of a DIA represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment. In addition, while some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income, per assumption #10, this isn’t the case in this situation. Consequently, the DIA column of the “Value/Death Benefit” section of the Exhibit is $0 for each year of the analysis.

On the other hand, there’s a projected value for the FIA from age 55 through age 79. This value is also the amount that would be paid to the FIA’s beneficiaries in the event of death. There’s a projected increase in value each year during the accumulation stage between age 55 and 67 equal to the net difference between the assumed annual return of 3% and the income rider charge of 0.95% of the income rider value.

Per the Exhibit, the projected value/death benefit increases from $56,278 at age 55 to $68,510 at age 67. Although the assumed premium bonus of 10% is on the high side these days, this is reasonable given the fact that FIA values never decrease as a result of negative performance of underlying indexes, the assumed rate of return of 3% is reasonable in today’s low index cap rate environment, and the assumed income rider charge of 0.95% of the income rider value is on the upper end of what’s prevalent in the industry. The projected value/death benefit decreases each year from age 68 to age 79 until it reaches $0 beginning at age 80 as a result of the annual income withdrawals of $5,764.

Conclusion

As discussed in Parts 1 – 3 of this series, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums during retirement in a given situation. Two of the differences, income start date flexibility and income increase provision, haven’t been addressed in this post.

In addition to the five differences, the amount of the investment required to produce a targeted lifetime annual income amount to pay LTCI premiums, including potential increases, will differ depending upon the particular FIA or DIA strategy used. In the illustrated case, which isn’t uncommon today, an investment of $50,000 resulted in an almost identical lifetime income payout whether a FIA with an income rider or a DIA is used.

As illustrated, the taxable income associated with a DIA in a nonqualified environment is much less compared to a FIA. As previously discussed, the amount of tax savings resulting from the reduced taxable income will depend upon an analysis of several factors and will vary each year. Ignoring the potential income tax savings resulting from the tax-favored DIA payouts, the FIA with income rider would be the preferred investment choice for many individuals in this case given the presence, duration, and projected amount of, the investment value/death benefit.

The FIA edge is reinforced by the fact that, unlike most traditional DIA’s, the income start date and associated annual lifetime income payout amount for FIA’s is flexible. This would be an important consideration in the event that the year of retirement changes. Furthermore, this is quite possible given the fact that the individual is 13 years away from her projected retirement year.

As emphasized throughout this series, the purchase of LTCI needs to be a lifetime commitment. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement. Whether it’s a FIA with an income rider, a DIA, or some other planning strategy that’s used for this purpose will depend on the particular situation.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 3 of 4

Last week’s post discussed the first three of five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. Once again, the differences are as follows:

  1. Income start state flexibility
  2. Income increase provision
  3. Income tax consequences
  4. Investment value
  5. Death benefit

This post will discuss the fourth and fifth differences. Part four will present a sample case to illustrate the use of a DIA vs. a FIA with an income rider to fund LTCI premiums during retirement.

Investment Value

Although guaranteed lifetime income is the primary purpose when using a FIA with income rider or DIA strategy for funding LTCI premiums during retirement, the presence of an investment value may be important for many people.

With traditional DIA’s, you purchase from a life insurance company the promise to pay a periodic income stream for either a term certain or lifetime, with or without inflation, beginning at a defined future date at least 13 months from the date of purchase. Although the present value of your future income stream represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment.

A FIA, on the other hand, has an “accumulation value” in addition to the right to receive income withdrawals when you purchase an optional income rider. The accumulation value is increased by initial and ongoing investments, premium bonuses if applicable, and periodic interest crediting. It’s reduced by income and other withdrawals, income rider charges, and surrender charges.

Death Benefit

There may or may not be a death benefit with both FIA’s with income riders and DIA’s. In the case of DIA’s, it’s a contractual issue vs. a function of the accumulation value in the case of a FIA.

Some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income. If this is the case, the income payment will often be less than what it would be if there’s no death benefit.

With FIA’s, the death benefit will be equal to the greater of the minimum guaranteed value or the accumulation value. As previously stated, the accumulation value is a moving target that increases and decreases as a result of various transactions. Depending upon the amount of cumulative income and other withdrawals as well as income rider and surrender charges, there may eventually be no minimum guaranteed value or accumulation value remaining.

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Annuities Fixed Index Annuities

12 Questions When Considering Fixed Index Annuities

It’s hard to believe, however, it’s been over a year since I began writing about fixed index annuities, or “FIA’s”, as a retirement income planning strategy. Beginning with the July 11, 2011 post, Shelter a Portion of Your Portfolio From the Next Stock Market Freefall, this has been the subject matter of virtually every Retirement Income Visions™ weekly post. Several of the posts, including the last nine, have been organized into multi-part series.

As evidenced by the titles of many of the posts as well as the number of parts in the various series, this is a highly technical area. Not to mention that there are currently 251 products offered by 40 life insurance companies to choose from.

The following is a list of 12 questions you should ask yourself when considering the purchase of fixed index annuities:

  • Are fixed index annuities suitable for me?
  • How will they fit into my retirement income plan?
  • Should they be part of my nonretirement or retirement investments?
  • What are the current and future income tax consequences?
  • Should I purchase an income rider?
  • When should I begin to purchase fixed index annuities?
  • How much should I invest in fixed index annuities?
  • Should I make ongoing investments in addition to my initial investment?
  • When should I begin to take income withdrawals?
  • Which indexing methods should I choose?
  • Should I consider products that offer a premium bonus?
  • Which product(s) is (are) best for me?

As you can appreciate, these aren’t easy questions to answer individually, let alone collectively. Next week’s post will provide you with guidance regarding how to go about finding answers to each of these questions.

Categories
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.

Categories
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

What is the Real Value of Your Fixed Index Annuity?

If you own a fixed index annuity (“FIA”), you can generally visit the website of the life insurance company from which you purchased your FIA to see the current value of your investment. In addition, your life insurance company will send you an annual statement shortly after the anniversary date of the issue of your contract showing you the accumulation value of your FIA on your anniversary date.

In addition to your anniversary date value, a typical annual statement will provide you with a list of the various transactions during the previous contract year, including investments, interest crediting, withdrawals, surrender charges, and premium bonuses and income and other rider charges if applicable.

How about if you purchased an optional income rider with your FIA? Will your annual statement show any information about the current value of your future income withdrawals? The answer to this question is generally no.

When you purchased your FIA, your financial advisor probably prepared an illustration for you that included the amount of annual lifetime income withdrawals that you will receive beginning at various dates depending upon when you begin your withdrawals. While the accumulation value of your FIA 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.

Assuming that your FIA includes an income rider, there’s a value that can be calculated and attached to the future income stream that you, and if married, your spouse will receive. Furthermore, the value of your income withdrawals may be greater than the accumulation value that’s shown on your annual statement.

If the value of your income withdrawals can be determined, why don’t life insurance companies include this information on annual FIA statements? The reason is because it can vary depending upon a number of assumptions.

Even though the amount of your income withdrawals beginning at various ages assuming you don’t make additional investments or take any non-income withdrawals can be predetermined when you purchase your FIA, there are other unknowns. Stay tuned to next week’s post to learn more.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 3 of 5

Retirement Income Center - Puzzle

I hope that you’re enjoying this series so far comparing two innovative retirement income planning tools – fixed index annuities (“FIAs”) with income riders and deferred income annuities (“DIAs”). Of the 12 features offered by FIAs with income riders that are listed in Part 1, we’ve looked at three features that are also offered by DIAs, and five that aren’t applicable to DIAs.

This post will discuss the remaining four features that are applicable to DIAs on a limited basis. They are as follows:

  1. Known future income amount at time of initial and ongoing investments
  2. Flexible income start date
  3. Greater income amount the longer you defer your income start date
  4. Death benefit

Known Future Income Amount at Time of Initial and Ongoing Investments

One of the really cool things about fixed income annuities from a retirement income planning perspective is the ability to structure a guaranteed (subject to the claims paying ability of individual life insurance companies) income stream to match one’s income needs. In the case of both FIA’s with income riders and DIA’s, the amount of the future income stream is known at the time of initial and ongoing investments.

When you purchase a DIA, a known amount of income, with or without an annual inflation factor, will be paid to you as an annuity beginning at a specified future date for either a specified number of months or for life, either single or joint as applicable. With traditional DIA’s, you make a one-time investment; however, there are a handful of products that offer you the ability to make ongoing investments.

Unlike traditional DIA’s where you generally make a single investment and you receive a specified amount of income beginning at a specified date, FIA’s with income riders have more variations. For one thing, assuming you’re working with a flexible– vs. a single-premium FIA, you have the ability to make ongoing investments in a single FIA. In addition, the income start date, which will be discussed in the next section, is flexible. While the future income amount is known at the time of initial and ongoing investments, both of these variables combine to offer a much broader range of possibilities than a traditional DIA when it comes to the income withdrawal amount.

Flexible Income Start Date

All FIAs with income riders have a flexible income start date with the ability to begin income withdrawals either in the year of purchase or one year from the date of purchase assuming you’ve reached a specified age, generally 50. There’s no requirement with FIA income riders to commit to the income start date at the time of purchase, and, furthermore, you don’t have to ever start taking income withdrawals if you choose not to do so.

Per the previous section, traditional DIAs begin their income payouts at a specified future date. There are some nontraditional DIAs that provide for a flexible income start date similar to FIAs with income riders.

Greater Income Amount the Longer You Defer Your Income Start Date

With all fixed income annuities where the income isn’t payable during the first year, i.e., single premium immediate annuities, or “SPIAs,” the longer you defer your income start date, the greater the amount of income you will receive. This is true whether the income payment is for a fixed term, as it is with some DIAs, or if it’s for life.

FIAs with income riders, with their built-in flexible income start date, include this feature. In order to obtain this benefit with a traditional DIA, you need to choose a later income start date at the time of purchase.

Death Benefit

Income withdrawal is an optional rider with FIAs. The base product has an accumulation value that’s increased by initial and ongoing investments, premium bonuses, and interest credits and is decreased by withdrawals and surrender and income rider charges. To the extent that there’s accumulation value remaining upon the death of the owner(s), it’s paid to the contract’s beneficiaries as a death benefit.

Traditional DIAs may or may not include a death benefit prior to annuitization. Once annuitization occurs, there’s generally no death benefit payable. If you opt for a traditional DIA that includes a death benefit before annuitization, the amount of the benefit will generally be equal to your investment amount; however, the tradeoff will be a reduced income amount than would otherwise be payable by a similar product that doesn’t include a death benefit.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 2 of 5

Retirement Income Center - Puzzle

As stated in Part 1 of this post, while fixed index annuities (“FIAs”) with income riders can be used to provide guaranteed (subject to the claims paying ability of individual life insurance companies) lifetime income beginning at a future date, they aren’t the only fixed income annuity game in town. Of the 12 features offered by FIA’s with an income rider that are listed in Part 1, three are offered by deferred income annuities (“DIAs”), four are applicable on a limited basis, and the remaining five aren’t applicable. The last group is the subject of this post.

The following is a list of the five features offered by FIAs that aren’t applicable to DIAs:

  1. Potential doubling of income amount to cover nursing home expense
  2. Investment value in addition to future income stream
  3. Protection from loss of principal
  4. Potential for increase in investment value
  5. Potential matching of percentage of investment amounts by financial institution

Potential Doubling of Income Amount to Cover Nursing Home Expense

The first feature, potential doubling of income amount to cover nursing home expense, isn’t a standard feature of FIAs with income riders. Of the 184 FIAs that currently offer guaranteed minimum withdrawal benefits (“GMWBs”), or income riders, 53, or less than one-third, include some type of long-term care benefit. When present, the amount of the benefit compared to the standard income amount, as well as qualification for this benefit, varies.

Investment Value in Addition to Future Income Stream

While DIAs and FIAs with income riders both offer the ideal retirement income feature of guaranteed (subject to the claims paying ability of individual life insurance companies) tax-deferred lifetime income, only FIAs also have a traditional investment value associated with them. Psychologically, this is comforting to investors who are uneasy with exchanging a lump sum of money “only” for an income stream who don’t understand the concept that the present value of the future income stream is an investment just like a brokerage account or any other investment asset.

Protection From Loss of Principal

Protection from loss of principal as well as features #4 and #5 are driven by feature #3, i.e., investment value in addition to a future income stream. The investment, or accumulation, value of FIAs, as it’s better known, will never decrease as a result of investment performance. It will either increase or remain unchanged on an annual or biennial basis, depending upon particular stock indexing strategies chosen. In the event of negative performance of a particular strategy, it will remain unchanged.

Potential for Increase of Investment Value

The investment, or accumulation, value of a FIA can increase to the extent that it’s allocated to one or more of the following three investment choices:

  1. Fixed account
  2. Traditional indexing method when the performance of the chosen index is positive
  3. Inverse performance trigger when the performance of the associated index is negative

The last choice, inverse performance trigger, isn’t a standard FIA indexing crediting option. Of the 253 FIAs on the market today, there are only 12 products available from two life insurance companies that offer this innovative strategy.

Potential Matching of Percentage of Investment Amount by Investment Institution

As previously stated, unlike DIAs that don’t have a traditional investment value associated with them, FIAs offer this feature. In addition, of the 253 FIAs available today, 130, or approximately one-half, have a percentage matching, or premium bonus, as it’s more commonly known, feature. A premium bonus is a fixed percentage of the investment in a FIA that’s added by some life insurance companies to the FIAs accumulation value during the first contract year and, sometimes, subsequent contract years, for a specified number of years.

As discussed in previous posts, the availability of this feature, as well as the bonus percentage amount when offered, shouldn’t be relied upon in and of itself to determine the suitability of a particular FIA in a given situation.

Categories
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.

Categories
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.

Categories
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.