A lot of annuities being sold today have these attached income riders. Sometimes they sound too good to be true. Remember that if it sounds too good to be true, it is every single time without exception. What we're going to do today is explain how these income riders work so you can make an informed decision on your time frame and your terms.
Boy, do we have a lot to cover with income riders so you'll be informed about what they do, so we're going to talk about an income rider? How does it work? What does it solve for? We will go over benefits and limitations, so you understand those fully because all annuity types have benefits and limitations. We'll talk about how to get a quote, what to look for in that quote, and how to structure the quote. We'll also talk about how it fits in the overall portfolio with what you have and what you're trying to achieve.
What is an income rider, and what does it solve for? An income rider is a guaranteed income payment at a future date that you choose. It's that simple. That's what it solves for. How does it work? It's a separate calculation from the annuity to which you've attached it. Let's say you attached it to a variable annuity or a fixed index annuity. Let's just visually draw a line down a blank sheet of paper. This site is the accumulation value side, which is the separate account mutual funds for variable annuities. For index annuities, it's the index options strategies; it’s going to create CD-type returns. On this side is that income rider guarantee. Two separate calculations, both are growing differently.
Typically, the income rider calculation is growing at a specific percentage that will grow during the deferral years; once you turn on the income stream, that percentage of growth stops. But you have to understand that percentage is monopoly money. You can only use it to calculate that first payment. It’s not interesting; you can't peel it off or cash it in or trade it to another annuity. That's how it works. Also, it's important to point out that with all lifetime income, it all comes down to life expectancy. With an income rider, the payment is primarily going to be the driving train of the pricing when you start. The older you are, the higher the payment, the younger you are, the older the payment, similar to Social Security. Everything's life expectancy base and life expectancy is the primary pricing mechanism, with interest rates playing a secondary role.
Let's talk about the benefits of income riders. There's a lot. These are excellent attachments if you're using them for the right thing. Primarily the goal is future income. You can set up the joint with a spouse or partner, which is good. You can use it inside of an IRA or non-IRA. You can attach it to a variable annuity or index annuity. I would encourage you to quote all carriers for the highest contractual guarantee. It is flexible. Let's just say you went into the contract and said, You know what? I want to start income in 12 years or seven years, and things have changed in-between, and you need to start sooner or later; you do that with an Income Rider. You're not locked into that initial start date that you put on the application. Obviously, with income riders, the benefit is you're never going to outlive the income. But some provide a death benefit, which is suitable for people who can't qualify for life insurance.
Also, some income riders provide confinement care benefits, meaning that when you can't do the sixth daily functions of life like feed yourself, clothe yourself, and bathe yourself. Number 1, life isn't good. Number 2, you're going to live 3-7 years is what they say, or what the study says. But what happens if you have a confinement care rider is they just increase the payments to you. When you're sick or you get your money back quicker, but you know what? That's a pretty good thing when you're at that time of your life when you need a little bit more extra income, maybe to cover medical expenses, etc. Those are the benefits of income riders.
Let's talk about the limitations of income riders. A lot of the limitations come about from some bad sales pitches and some misconceptions that people have hearing a sales pitch, whatever. But with that being said, we have to cover them. You have to understand what they are and make a good decision. Number 1, a lot of these income riders have a high percentage yield, and you go, "Wait a minute, that sounds great. I'm getting a six percent or seven percent growth on that income rider amount." That does not yield. Jimmy Carter is not in the office. There's not some genius at an annuity company that's figured out how to give you high yield, okay? That is monopoly money that grows until you decide to take income.
That percentage stops when that income rider also, to amount. You can't peel off the interests; you can't transfer it; you can't get it in a lump-sum. But that's okay if you know the rules. But don't call me up and say, "Hey Stan, I got a seven percent annuity or an eight percent annuity." I get that all the time. No, you don't. You have an income rider, monopoly money, which can be used to calculate that first income payment. That's okay. Also, on that income, rider amounts that have grown by those percentages, that annual fee from the rider are taken out of that other side.
So, I remember drawing the line down the middle sheet of paper, accumulation value, and income rider value? The rider fee comes out of the accumulation value for the policy’s life, and it grows by that percentage during the deferral years. You need to know that. Let's just say the percentages, 7.2 percent; it’s growing by on this side. You held it for ten years. When you started the percentage with a one percent annual fee, and it's growing by 7.2 percent, it doubled at the end of 10 years, when you turn on the income streed. The fee is now two percent, and you've locked in that two percent annual fee for the life of the policy. Is that a good thing or a bad thing? It's a bad thing if you don't know it, but if you know it, then you'll factor that into your decision. Because if you're buying the income rider for what you should be buying it for, which is the guaranteed income stream in the future, then all of that's irrelevant, but you need to know all of those limitations.
Also, from a taxation standpoint, always go to a CPA or tax lawyer for real tax advice, but most income riders out there are LIFO, last-in, first-out gains, first at ordinary income levels.
Let's talk about structuring choices and how to get a quote and all of that stuff that's important. With income riders, you can have it just on your life, or you can have a joint life with a spouse or partner, etc. When you pass away, the majority of income riders, if both of you pass away at the same time and it's joint, 100 percent of the unused money and the accumulation value goes to the beneficiaries. If the income rider is a death benefit, they get that amount. But typically, the annuity companies do not keep a penny even though they're on the hook to pay you for the rest of your life.
From the quality standpoint, you quote income riders like you quote all annuities. All annuities are commodities. There's not one company that has the best, even though agents and advisors might tell you they found the best one for you. In translation, they might have found the best one for them, or they haven't done their homework, given them a little bit of leeway. You should quote it just with all carriers as many carriers as humanly possible for the highest contractual guarantee, knowing that those quotes change all the time, every 7-10 days in a lot of cases. But you need to quote them all. It's like buying a plane ticket. That's how you go about finding the best income rider because it's about the highest contractual guarantee for your specific and customized situation at the end of the day.
Where does it fit in your portfolio? We've gone over a lot of the good and the bad. Income riders are for income later. It's an income product; it’s a future pension guarantee that you can set up for yourself, use an IRA or non-IRA money. That's the primary reason you use it. Secondary reasons would be legacy. If there's a death benefit attached, you could use it for that, or if you wanted to do joint life income with a spouse or partner, that legacy would be the continuation of the income stream, uninterrupted and unchanged. Also, you could use it for confinement care if you can't qualify for traditional long-term care or you need secondary coverage, a little bit more coverage to make you feel better and more secure, you can use it for that as well, which in essence is getting your money back quickly when you get sicker. It's not a bad thing, but it's just reality. With that, that's where income riders fit.
Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.