Income riders and parachutes: the three key questions advisors need to be able to answer
August 15, 2013 by Shawn Moran
So much of the innovation taking place in the annuity industry today is on the income side of the equation. With lower caps, the accumulation story is not a very compelling one; however, told properly, the income story is one that is both compelling and vital to our clients having confidence that their retirement money will live as long as they do.
The optional income riders that are available on most fixed and fixed index annuity products today are the chief supporting actors in the income story. The client, of course, is always the main actor. It is how we, as professionals, position these products and demonstrate their worth to a client that will often determine whether the client takes action and integrates them into their retirement plan.
Let’s look at the three key questions we need to be able to answer for clients when they are considering an income rider:
1. What are they?
2. What is their value to a retirement?
3. Are they worth the cost of the fees that are charged?
What are they?
Although they come in many shapes and sizes, income riders at their core are designed to give a client a contractual promise from an insurance company that a stipulated amount of income will be paid to them for the rest of their life, even if the account balance were to go all the way down to zero.
There is typically both a deferral guarantee and a withdrawal guarantee built into an income rider. In the years that the annuity is being left alone to grow, there is an income account value that is growing each year.
Importantly, we need to be very clear with clients that this income account value is not available as a lump sum withdrawal in the way that their account value is. When the client is ready to begin receiving income, a withdrawal rate is applied to that income account value to determine how much income the client can enjoy.
What is their value in retirement?
So much of what is done today in retirement planning is based upon projections: “If the market does this, and if inflation does that, then retirement will be a comfortable one for you.” Income riders on an annuity are based not upon projections, but upon predictability.
Consider a hypothetical scenario. Let’s say you have 55-year-old client who wants to retire in 10 years at age 65. He has $250,000 that he places in a fixed index annuity with an income rider that has a 6 percent annual rollup during deferral, and a 5 percent withdrawal guarantee when he begins to receive income. In 10 years, the income account value would be $447,711. A 5 percent withdrawal guarantee would produce $22,385 in annual income that the client could not outlive, assuming he abides by the terms of the annuity contract. Ask yourself: Is there any other financial product that can, with that degree of predictability, produce that much in guaranteed future income?
Are they worth the cost of the fees that are charged?
You probably have heard clients ask the question, “Why do I need an income rider when all the insurance company is doing is sending me my own money?” Well, that is absolutely true, and the client would be correct in thinking that they could withdraw their own money for income from lots of other financial products without paying the fee associated with an annuity income rider. But in a world of exploding longevity and increasing economic turbulence, will those other products continue to send them a check each month even if there is a zero balance in the account?
That is the value of the income rider. I tell my clients that I am a believer in worst case scenario planning. We can hope for the best, but it is important to plan for the worst. When you hit a zero balance in any other financial product, the worst case scenario is that there is no money left in the account, and the income that is needed for retirement stops. With a fixed annuity with an income rider guarantee, only the first part of that worst case scenario would apply, because the income checks would continue for the rest of the client’s life.
Let me close with an analogy. Imagine you were going to go sky diving. You drive to a sky diving school and, after signing lots of documents that state that if you end up doing an imitation of a pancake on the airport tarmac, you blame no one but yourself, you reach for your checkbook to pay the $200 fee. As you are about to fill in the dollar amount, you nervously look up and ask the flight instructor, “Has anyone ever died doing this?”
He answers you by saying, “Yes. A few people have died, but there is a 98 percent chance that your chute will open and you’ll be fine. However, for an additional $20, you can rent an extra backup chute that would give you a 100% chance of your chute opening.”
Let me ask you: after hearing that, would you be writing a check for $200, or for $220?
I thought so.
Me, too.
That is the value of an income rider. Without it, the client may very well never run out of money. With it, they can rest assured knowing that they won’t.
