One of the reasons why people are suspicious of annuities is because they have certain provisions that can be disturbing. For example, if you take out an annuity contract with the expectation that it will provide you with an income for at least the next 20 years, but you die after 10 years, the remaining balance in the contract will revert to the insurance company, not to your heirs.
Annuity contracts have a number of such provisions. Because of their emphasis on providing lifetime income benefit, annuities must necessarily have certain provisions that enable an insurance companies to pay that income, even if the value of the annuity fully depletes. On the surface, that might cause you to completely avoid annuities, even though they offer powerful benefits, particularly to retirees.
But if you like the benefits of annuities, but you're not comfortable with some of the ways that they work, there are workarounds. They're referred to as riders, and they can remove some of the more questionable provisions that are common in annuities. There are several different annuities, that address different concerns.
There are also different versions of each option, though sometimes those versions are just a matter of describing the same option but with different language.
There are also fees involved with each rider. Generally, those fees are assessed in the form of a reduced income payout. For example, if the annual payout from annuity is 6% per year, and a particular rider costs 0.75% per year, the annual payout will be reduced to 5.25% for the life of the annuity.
Here are some of the more common annuity riders:
1. Guaranteed Withdrawal Benefit
A guaranteed withdrawal benefit rider comes in at least two different flavors, a guaranteed lifetime withdrawal benefit (GLWB), and a guaranteed minimum withdrawal benefit (GMWB).
Normally when you invest in an annuity, there are only two ways that you can withdraw money from a plan:
1. “Annuitize” the funds – which means creating regular distributions, or
2. Make the withdrawal, and pay surrender charges
A guaranteed withdrawal benefit rider provides you with another way to get access to your money. The GLWB rider provides for immediate withdrawals from the invested balance, without having to annuitize the investment. The amount that you can withdraw is determined by a percentage of the total investment in the annuity.
And although you make the withdrawal, the remaining funds in the annuity continue to be invested according to the original contract. In most cases, the date at which you will begin receiving normal income payments from the plan will be delayed to a later date.
A GMWB provides the annuity owner with the ability to withdraw a certain percentage of their original investments from the annuity until they have withdrawn the full amount of that initial investment. This protects the principal invested in the annuity by the annuity owner. For example, the annuity owner can withdraw 10% of the annuity balance each year, until the full amount of the initial investment has been fully recovered. In the meantime, the remaining balance in the plan continues to grow with the market.
2. Lifetime Income Benefit Rider
The lifetime income benefit rider (LIB) is commonly available with variable annuities. With the rider, the insurance company guarantees that you will receive regular income payments from the annuity, whether that is monthly, quarterly, or annually. The payments will continue for the rest of your life, even if the actual balance in the annuity is fully depleted.
An LIB can ensure that you never outlive your money, which is a common concern of retirees. For example, let's say that you invest $200,000 in an annuity. The contract provides for a 5% annual income – but after 20 years the annuity is fully depleted. The insurance company will continue paying you the agreed-upon annual income benefit, in this case $10,000 (5% of $200,000) for the rest of your life.
An LIB rider is an excellent idea for a person who begins taking income benefits at say, 60, and expects to live another 25 or 30 years.
3. Death Benefit Rider
One of the common disadvantages of annuities is that they are established as living benefit contracts. That is, they provide you with income benefits for the rest of your life, but once you die there is no insurance benefit for your heirs.
This can be an obvious disadvantage you purchase an annuity with the intent that it will provide income for you for 20 years, but you die after just 10 years. The remaining funds in the annuity contract will revert to the insurance company. And since you are only halfway through the expected term of the contract, that balance will be substantial.
The death benefit rider gives you the ability to provide death benefit for your heirs in the event of your death, converting the annuity to both a living benefit and a death benefit contract.
A death benefit rider guarantees that your heirs will receive at least the amount of the premium that you paid for the annuity. For example, if you pay $250,000 to establish the annuity, and as of the date of your death only half of the premium has been returned to you, your heirs will be entitled to death benefit of $125,000.
4. Long-Term Care Rider
As people are living longer all the time, providing long-term care has become a growing concern. But the basic problem with long-term care is that it's incredibly expensive. Not only that, but there are a decreasing number of insurance companies that provide policies to cover long-term care.
But you can add a long-term care rider to an annuity, so that you will have that contingency covered within your plan. The annuity will provide the income specified in the contract, but will also pay a long-term care benefit should that become necessary.
What the long-term care rider does is to adjust the income payout to help accommodate the cost of long-term care. For example, let's say that the cost of long-term care will be $6,000 per month. If the annuity is scheduled to provide you with monthly income payments of $3,000, the payment will double to $6,000 per month in the event that you have been medically determined to require long-term care.
A long-term care rider usually provides a benefit that will be double the normal income payment from the annuity. For this reason, if you know that long-term care in your area runs about $6,000 per month, you might set your annuity with an income payment of $3,000 per month. That will give you the ability to be able to afford long-term care, should it become necessary.
The increased payments are typically available for up to 60 months, and generally apply to just one person – either you or your spouse. It also typically applies to a single long-term care situation. For example, if you are in long-term care for three years and then come out, the benefit will not carry over to a second stay.
5. Cost of Living (COLA) Riders
Annuities come with a specified monthly income. That income is determined at the time that you take the annuity contract, and is fixed for the entire term. While that can provide a guaranteed income to you as the annuity owner, it does not account for inflation.
For this reason, you can add a cost of living adjustment (COLA) rider to your annuity. It provides for increases in the monthly payments, based on a measure of inflation.
COLA riders use two methods to calculate increases in your benefit payments. The first is based on the rate of increase based on an actual statistic, like the Consumer Price Index (CPI), which is provided by the Bureau of Labor Statistics. It is the most common measure of inflation used throughout the economy. Annual changes in the CPI are used to determine changes in your monthly benefit, which can also go down if the index reports a negative change (deflation).
The second is based on a level percentage increase. For example, you can select a specific percentage, say 3% (which is roughly the average inflation rate over the past several decades). That will provide you with an annual increase in your benefit payments, regardless of what is actually happening with the rate of inflation. You might use this method if you believe that the CPI is not entirely accurate. However should the rate of inflation increased beyond 3%, you would be better off using the CPI method.
6. Refund or Return of Premium Riders
This rider is very similar to the death benefit rider, in that it provides a death benefit to your heirs, in addition to the living benefits that are paid by the annuity itself.
Under a refund or return of premium rider, the insurance company will return invested funds to the named beneficiary in the rider in the event that the annuity owner dies before the principal value of the annuity has been paid out. It effectively provides a cash refund that’s equal to the premium paid to the insurance company to establish the annuity, less benefit payouts made between the time the annuity begins and the owner dies.
So if you paid a $200,000 premium into an annuity, and collected benefits for 10 years totaling $100,000, then the remaining $100,000 will be paid to your beneficiary.
In certain variations of the rider, the insurance company will also include interest earned on the annuity investment while the contract was in force.
Naturally, the longer the annuity contract is in force, and the more principal is paid out, and the lower the death benefit will be. It is even possible that after 20 years or more have passed, that no death benefit will be paid out because the annuity has been depleted.
7. Impaired Risk Rider
An impaired risk rider is available in the event that you establish an annuity, but you have a health-related condition that might shorten your life. If this rider is added to your annuity, it will generally accomplish its mission by providing you with a higher income payment over what will be a presumably shorter-term.
Medical conditions can include heart disease, cancer, stroke, alcoholism, leukemia, cirrhosis of the liver, high blood pressure, leukemia, and a host of other health-related conditions.
This rider will of course add a health evaluation to the mix. Much as would be the case with a life insurance policy, the insurance company will likely require that you provide documentation to support the claimed health condition. This could result in an investigation into your health history that is very similar to what would be done with a medically underwritten life insurance policy. Some companies may even request that you undergo a medical exam.
8. Commuted Payout Rider
A commuted payout rider enables you to withdraw a lump sum from your annuity. It is very similar to the guaranteed withdrawal benefit rider, and even perhaps a different name for the same rider offered by different companies. Since annuities are typically set up to provide you with a steady stream of income over your lifetime, they generally restrict your ability to make lump sum withdrawals. This rider can open up that possibility.
Typically the rider comes with a withdrawal limit that is based on either a percentage of the premium paid for the annuity, or a fixed dollar amount. In addition, withdrawals are typically limited to the first few years that the annuity contract is in force.
9. Guaranteed Minimum Accumulation Benefit Rider
A guaranteed minimum accumulation benefit rider (GMAB) is typically attached to a variable annuity, designed primarily to protect the annuity from declines in the contract value due to changes in the financial markets.
The rider guarantees that the minimum amount received will be the dollar amount invested in the contract, or the gain in the value of the contract, between the time that it is established and it begins making income payments.
There is some risk in taking this rider. The benefit will only occur if the value of the annuity falls below the guaranteed value. If it never does, the annuity owner will have paid for a benefit that will never be received. Some insurance companies have provisions within the rider that the cumulative costs of the rider is returned to the annuity owner, if the value of the annuity is higher than the guaranteed value. That is a stipulation that you will want to be certain is in place before adding this rider to your annuity.
10. Guaranteed Minimum Income Benefit Rider
A guaranteed minimum income benefit rider (GMIB) ensures a specific income payment regardless of the performance of your annuity since the contract is put in place.
Under a guaranteed minimum income benefit rider, your income payments are typically based on several essential calculations. For example, some of the calculations include:
- A payout based on a percentage of the annuity value
- The actual value of the annuity at the time that income payments begin, or
- The highest contract anniversary value of the annuity
Under the terms of the guaranteed minimum income benefit rider, you would be paid based on the option that provides you with the highest income. So if you invested $200,000 in a variable annuity, and after 10 years it was worth $250,000, you might instead be paid based on say, a 5% interest rate on the $200,000, compounded over 10 years. That would result in a value of $325,779. Your income payments would be based on the higher of the two numbers.
Adding a guaranteed minimum income benefit rider is an important reason why an investor might choose an annuity over simply investing in a mutual fund. It means that the investor has an opportunity to have a higher value than what a mutual fund can provide, particularly in a poorly performing market.
11. Disability, Unemployment & Terminal Illness Riders
These are the riders that relate to either your health condition or employment status. There is a rider customized for each situation.
A partial disability benefits rider pays benefits if your ability to earn a living has been impaired by a disabling event. Unlike a standard disability insurance policy, it does not provide benefits based on your actual employment earnings. Instead, it pays you a certain percentage of the monthly income payment that was agreed upon under your annuity contract. It usually makes these payments for certain specific period of time, which is generally not more than one year.
The rider may also include benefits for unemployment, though that can also be established as a separate rider. The annuity will pay you a certain percentage of your monthly income payment agreed upon in the annuity contract, for up to one year.
In either case, surrender charges will be waived.
A terminal illness rider will enable you to access a certain percentage of your annuity due to a health condition that leaves you with a life expectancy of one year or less. Within that time, surrender charges will be waived.
Wrapping It Up
As you can see, there is a rider for just about any contingency can imagine. If you're considering investing in annuity, be sure to bring up any concerns that you have, either about the annuity itself, or about your own individual situation. Chances are there is a rider that can be added to the annuity, that will deal with whatever the issue might be.
