Annuity Income Riders & Guaranteed Roll-Up Rates
What Are Annuity Income Riders?
How can one annuity offer a return as high as 8% when most others are offering closer to 4%? The answer is annuity income riders and roll-up rates. Riders are add-ons used to customize a plain annuity into one that is designed for your particular set of goals. Death Benefit Riders are the most commonly used annuity riders.
A few other examples would be Nursing Home Riders, Impaired Risk Riders, Disability, Unemployment & Terminal Illness Riders. Each Rider or add-on is designed to go into effect when or if certain life events take place.
Each Rider comes with its own fees and conditions:
For our purposes, we will be focusing on Income Riders. Adding an annuity income rider to a deferred annuity policy will, for an additional annual fee, provide a lifetime income stream that you can turn on in the future. Some Income Riders grow at a guaranteed rate that will compound during the deferral years.
Although rates can vary, Income Riders will typically cost you around 75 basis points annually. You will be charged from the very first day of the annuities inception, all the way through the payout phase or your death. This cost can be mathematically interpreted as a reduced interest return. For example, if the annuity is offering you a rate of 3.00%, and the rider cost is 75 basis points (bps), the net yield would actually be an annual return of approximately 2.25%.
Now for that 8%…
Annuity income riders guarantee are sometimes called a Roll-Up Rate. A Roll-Up Rate is simply a guaranteed rate of return, as long as you are deferring. So once an income rider is purchased, a “Phantom” account is created, this is often referred to as an income calculation base, or benefit base.
Think of it as there being two accounts being created for your one annuity. One contains your principle (account A) growing at a rate of say 3%, the other account is your principal PLUS the 8% Roll-Up earnings(account B).
You are not ever going to be able to withdraw as a lump sum the funds in this Phantom Account B, the roll-up earnings in account B are not going to be paid out to beneficiaries if you die and maybe most importantly, understand that Riders are a type of annuity guarantee.
Strength Of The Insurance Company
Be sure your annuity issuer has the ability to pay, because you are not guaranteed anything on a Federal or State level with regards to earnings from Riders, unlike some of your principal, which is guaranteed to a certain extent.
The insurance carrier will use account B as the income calculation base to determine the amount your monthly payments will be (Income calculation base, or benefit base). Now as long as your funds are being deferred, also known as being in the accumulation phase, account B is going to be growing at this promised 8% interest.
Based on that fact, account B should have much higher returns than your actual account (account A) due to the fact it was growing at 8% which is much higher than the actual accumulation value. On paper, this is true. However another factor typically coupled with this income calculation base is something called a Guaranteed Withdrawal Percentage. This is an age based table that limits the amount you can withdraw annually.
Once you actually start making withdrawals, it is your benefit base, multiplied by your guaranteed withdrawal rate, which determines how much money you receive. And that, of course, is the number that really counts; it represents your guaranteed minimum income in retirement.
On average, at age 60, you would be limited to 4% – 4.5% of the Income Calculation Base annually.
By using both the (account B) benefit base and the guaranteed withdraw percentage, the insurance carrier is able to offset this higher rate of return by limiting how much you are receiving annually coupled with the fact that you will not ever actually take possession of the total amount, nor are you able to walk away with the returns from this higher interest rate.
Your true account value is the actual value of the account where you put your original investment. In other words, the cash value of (account A). It might be larger, or smaller, or the same as the benefit base (account B). But the roll-up has no effect on the real world account value.
If you were to instead choose to use the generic Systemic Withdrawal Option, available in most annuities without a fee, you will often receive a higher monthly payout option, earn a current, real life rate of return and retain control over the distribution of your entire account.
Think before you act!
There are without a doubt going to be circumstances where an income rider and roll-up rate will be a perfect fit for certain goals and scenarios. However, there are a great many moving pieces and restrictions involved so it is important to work with someone you trust to determine when or if you fall into these circumstances.
In the end, if you are being offered 8%, you now know that it’s not as simple as it sounds.