The practical impact of the optional rider fee will be to reduce the contract value a bit more quickly leading to a lower death benefit than otherwise. But with the focus on income rather than accumulation, the rider fee is of secondary importance. The goal is not to find the lowest rider fee, as it would generally support a less generous guarantee, but to find the FIA that offers the most value through lifetime income to the individual for a given rider cost. When the individual survives long enough that the contract value of the FIA is depleted, the benefit continues to support lifetime income.
There is another way that lifetime income benefits can be structured that moves away from the hypothetical benefit base and the rollup rate. This alternative approach also exists for deferred variable annuities, but it is more commonly found with FIAs and so is discussed here.
In the alternate formulation, a lifetime withdrawal percentage, which is still defined by age bands, is determined at the time the income rider is added to the FIA. In this case, it is the age that the benefit is purchased rather than the age that income begins. Then, rather than using a rollup rate with a benefit base, there is a deferral credit that increases the withdrawal rate for each year that the owner defers the start of their lifetime income distributions. When lifetime distributions begin, they are set as a percentage of the contract value at that time, where the percentage is rising over time on account of the deferral credits.
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For example, suppose a fifty-five-year-old purchases an FIA that includes this type of income rider. For this contract, the withdrawal percentage when purchased at fifty-five is 4.5 percent, and the deferral credit is 0.3 percent for each year that the individual delays the start of income. The individual plans to retire at age sixty-five, which would provide ten years of deferral. That would mean that the lifetime withdrawal percentage is 7.5 percent (4.5 + 0.3 x 10) of the contract value at that age. In this case, principal is protected only on a gross basis before the rider fee is applied at the end of each year. If the annual rider charge is 1 percent, then in the extremely unlikely event that the index experiences a negative return for all ten years, the rider fee would reduce the contract value on a $100,000 premium to $90,438. With a 7.5 percent withdrawal rate, this provides $6,783 of lifetime income. However, this minimum amount is extremely unlikely to be realized, as it would require ten consecutive years of negative market returns—imagine what this would do to an unprotected investment portfolio—and any upside growth and positive crediting during these ten years would contribute to a higher level of protected lifetime income.
This is just an alternative way to account for potential market growth during the deferral period that can be alternatively applied through a higher payout rate with a deferred income annuity or with a rollup rate for a VA or FIA. As always, rather than getting caught up with thinking about how the different factors interact, it is better to investigate what the guaranteed income level would be at the targeted retirement date, and to then consider whether there are additional reasons to choose an annuity with less guaranteed income, such as the liquidity provisions or the upside growth potential.
This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon
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