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Annuity Income Benefits – Learn Annuities Pros and Cons, How Annuity Income is Calculated


What is an Annuity Rider?

Rider(s) is an insurance term for optional features annuity owners can add to their contract. The purpose of a rider is to provide an enhanced benefit such as an enhanced income benefit, death benefit, long-term care benefit, etc.

It’s important to note that Living Benefit Riders exist for both Life Insurance Policies and Annuities. Although the terms are the same, the purpose of a Living Benefit Rider in a Life Insurance Policy is very different from a Living Benefit Rider found in annuities.

Living Benefit Riders associated with Life Insurance policies are tied to the death benefit, whereas those found in annuities are linked to the income benefit.

Some Living Benefit Riders can add value to an annuity contract, and some don’t entirely offset its cost.

This post will give you an inside look at the inner workings of Annuity Living Benefit Riders and arm you with information that every annuity customer needs to know!

What is an Annuity Living Benefit Rider?


A “living benefit rider” is an optional “enhanced” income benefit that contract owners can add to their annuity. Annuity income riders often come with an additional cost, but some annuity products have “built-in” living benefit riders.

Benefits of a Living Benefit Rider

Living benefit riders tend to offer more flexibility in providing a guaranteed income stream. Additionally, two of the three types of Living benefit riders provides a guaranteed income stream without having to annuitize your contract. We’ll provide a recap on what it means to annuitize an annuity below.

The main benefit to a Living benefit rider is to provide a safety net for income in the event of poor performance. This is why they’re very popular in Variable Annuities and often presented as a “downside protection” feature.

What is Annuitization?

Deferred annuity products include a growth component and the option to annuitize the contract for a guaranteed income stream.

As a recap from my previous post:

“Once you annuitize your contract, you are trading your cash value for guaranteed payments that continue based on the payment period you selected (lifetime, joint lifetime, period certain, etc.).

The benefit? Your income will continue for the requested period (lifetime, joint lifetime, or a specified period). For example, if you choose the single-life payout, then payments will continue no matter how long you live.

The risk? Suppose you chose the straight single-life payment option and suddenly passed away a couple of years after payments had started. In that case, there is no remaining cash value to pass on to your beneficiaries as it was converted into an income stream when you annuitized the contract.

Therefore, you should consult with your advisor or annuity specialist before starting payments because once annuitized, it cannot be reversed.” Learn more…


Elements of a Living Benefit Rider


There are 3 parts to a living benefit rider:

  • Income Benefit Base
  • Withdrawal Rate
  • Stipulations

What is an Income Benefit Base?

An income benefit base is a different value from the contract value. The income benefit base value is an accounting figure that the insurance company will use to calculate the available annual payout amount.

The benefit base value typically grows at a different rate from the contract value, but that’s not always the case.

For example, some income riders have no separate growth rate for the income benefit base and the value is equal to the contract value.

No enhanced growth rate for the income benefit base doesn’t necessarily mean the income amount will be low. A good portion of riders structured this way offer higher withdrawal rates.

The most common income benefit-base misunderstanding I came across was the purpose of this value, possibly because of the separate growth strategy it’s associated with. I’ve met with a fair share of annuity owners that thought the income benefit base was a value that becomes liquid if the contract value was ever lower than the income base due to market volatility.

Needless to say, they were all very disappointed to learn that the benefit base value is not tangible, has no cash value, and can’t be withdrawn as a lump sum. Therefore, being able to differentiate these two values is crucial.

 See Below:

How does an annuity work?

Income Benefit Withdrawal Rate

The withdrawal rate associated with income riders is another important factor to consider. Why? Because as it is used to calculate the maximum annual withdrawal amount.

The withdrawal rate is a percentage rate that the insurance company predetermines.

See below:

Deferred Income Annuity riders

Some withdrawal rates remain the same for the duration of the contract. However, it’s more common for withdrawal rates to increase as you age (which makes sense since your life expectancy decreases as you age). The formal term for this are “age bands.”

See below:

What is Annuity Income

Common Stipulations

  • Earliest income start date: Some Living Benefit Riders have no waiting period. This provides annuity owners the flexibility to activate the income rider right after the annuity contract is issued. Others have waiting periods before you can activate the rider and start taking income. The issuing insurance company predetermines waiting periods. Some waiting periods only apply until the annuitant(s) reach a certain age (usually age 59.5), and some are established for a certain amount of time regardless of the annuitant’s age.
  • Excess withdrawals: Any withdrawal exceeding the maximum annual payout amount could negatively impact your income benefit base, reducing your yearly payouts going forward.
  • Investment Restrictions (Variable Annuity Products Only): Some Living Benefit Riders stipulate the type of sub-accounts you can invest in or how your contract value (cash value) is invested.

Example:

80/20 portfolio instead of 100% in equities. 


Types of Living Benefit Riders


Guaranteed Minimum Income Benefit (GMIB)

GMIB Income Benefit Base

A guaranteed minimum income benefit offers a guaranteed growth rate (such as 4%, 5%, 6%, etc.) on the income benefit base value for a certain period of time. The maximum withdrawal rate is often the same or close to the benefit base’s growth rate.

Example:


If your benefit base is guaranteed to grow at 5%.
The maximum withdrawal rate will likely be be 5% or just under 5%.

The benefit base’s guaranteed growth period is much longer than other Living Benefit Riders. Therefore, some annuity owners elect to use the maximum withdrawal amount as an initial income stream.

However, if you choose this route, ensure you do not take more than the maximum annual withdrawal amount allowed. Otherwise, the benefit base will be reduced accordingly, negatively affecting your guaranteed income amount going forward.

GMIB Withdrawal Rates

GMIB withdrawal rates are not used to determine the guaranteed income amount. Instead, it is the maximum amount you can take without negatively affecting your guaranteed income stream.

GMIBs are the only Living Benefit Rider that requires you to annuitize the contract once you’re ready to solidify the guaranteed income stream. Once you’re prepared to annuitize, the insurance company will utilize the benefit base value and other variables to calculate your guaranteed income amount, which is often close to the maximum withdrawal amount available on your contract.


I think GMIBs are the most complicated type of Living Benefit Rider mainly because of the extra step of having to annuitize the contract for a guaranteed income stream. Still, it’s the only income rider offering more options to maximize the income stream.

Still, it’s the only income rider offering more options to maximize the income stream.

Guaranteed Lifetime Withdrawal Benefit (GLWB)

Guaranteed Lifetime Withdrawal Benefits are similar to GMIBs because the income benefit base often has a different growth strategy.

The main difference between a GLWB and a GMIB is that annuitization is not required for GLWBs. Your guaranteed income amount will be the withdrawal percentage multiplied by the income benefit base value.


Variable Annuities frequently offer both GMIBs and GLWBs that offer a guaranteed growth rate on the benefit base value, while Fixed and Fixed Index Annuities typically favor GLWBs.


Annuity meaning with example

Over time, Fixed Index Annuity companies have developed creative growth strategies for the income benefit base.

Below are some different growth strategies that can be found in Fixed Index Annuities: 

  1. The growth simply coincides with the contract value. 
  2. Guaranteed growth rate for a certain amount of time.
  3. Accelerated interest credits, where the growth of the benefit base is based on the interest you earned on your cash value multiplied by a “bonus” rate determined by the insurance company.
  4. The benefit base receives a one time “bonus” on the issue date, plus the same interest that was credited to the contract value.
  5. The benefit base receives a one time “bonus” on the issue date, plus an accelerated rate of the interest that was credited to the contract value.

Example of option 3:

Your contract value earns 3% in interest this year.

The “bonus” rate is 150%.

Your income benefit base will earn 150% of 3%

1.50 x 3.0% = 4.50% of interest credited to the benefit base value.

Believe it or not, that is a “simplified” explanation for these strategies, showing you how convoluted riders can be.

Guaranteed Minimum Accumulation Benefit (GMAB)

This rider applies to variable annuities only as it provides reassurance that you will have access to the higher of your contract value or the premiums paid (minus any withdrawals) despite market performance.

In other words, if you choose to activate your income stream during a market downturn and your contract value is less than your original investment amount – your income would, at the very least, be calculated against the higher of those two numbers.

Example:

Your original investment amount: $300,000

Contract value on the income start date: $277,000

Allotted Income Withdrawal Rate: 5%

Income is calculated using the higher value: $300,000

$300,000 x 5% = $15,000 annual payout amount

Items to consider:

  • Living Benefit riders can sometimes have a waiting period on when income can be activated. 
  • Since there is no separate growth strategy for the income benefit base, it is common to have higher allotted withdrawal rates on GMABs.

Living benefit rider fees

Although it’s common to charge a fee for a rider, some contracts have built-in riders at no cost. Rider fees on an annuity can range from 0.15% – 2.50%.

Multiple riders can be added to the contract, which can cause a layer of fees to eat away at the growth on your contract. 


Is a Living Benefit Rider Right For You?

Living Benefit Riders offer a “sleep at night” factor to investors who have reservations about the long-term performance of their investments. If you uncover a need for income insurance and would like to learn how to compare riders and how to determine which ones are the most fruitful, click here.


Disclaimer: The opinions expressed in this blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security, investment, or insurance product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.