Annuity Riders Explained

Just like any other major insurance product annuities have many nuances and challenges that affect investors understanding of what they are really purchasing. As the popularity of the annuity industry has increased in the last decade it has been difficult to separate efficient strategies from the noise. So let’s break down some common annuity riders, whether they are effective and who they can benefit.

Long Term Care Benefit

Long Term Care refers to care provided when someone cannot perform two out of the six basic daily tasks. It is an especially important consideration for retirees and those who are approaching retirement. Although life expectancy has been trending down in the last few years, there is still a 50% chance that one partner in every couple will live to 90. Since old age comes with medical issues, the longer you live the greater the chance that you might need long term care. In fact, 70% of people over the age of 65 will need some form of long term care and 63% of their caregivers end up dipping into savings or their own retirement. In order to avoid these costs many turn to different forms of insurance. However, long term care insurance can have very expensive premiums that continue to get more expensive as you age. The use it or lose it policy can also hinder other retirement needs and pursuits that are crucial to a vibrant retirement. The annuity long term care benefit is a rider that helps solve the long term care issue and does not infringe on retirement income or investments. The rider allows you to increase payouts from 150-200% in order to cover long term care costs. The increase will last until the account value runs out. Afterward, the payments will return to the original agreed upon payments. This kind of rider is responsible for 12-15% of annuity sales each year and recently in 2014 long term care annuities outpaced basic long term care insurance. Just like any other rider, there is a cost associated with long term care riders. The average cost is around 1% of account value but it may differ from company to company. If long term care is one of your major concerns this may be something you should look into.

Guaranteed Lifetime Income

This is also known as a lifetime income benefit and it is basically a promise from the insurance company that they will pay you for your entire lifetime. Even if your annuity is depleted the payments will continue and the remainder of your accumulation would be distributed to your beneficiaries. Most of these riders add a guaranteed minimum growth rate provision that gives the interest a floor if the underlying investments underperform. Planning for retirement involves answering many fears and concerns, the most common being running out of money. Three out of five middle-class retirees can expect to outlive their financial assets if they attempt to maintain their pre-retirement standard of living according to a 2008 Ernst & Young study. An annuity with a lifetime income benefit would ease those fears. It’s almost like getting a paycheck for the rest of your life and it can provide stability and predictability to your retirement.

Cost of Living Riders

A retiree’s response to inflation can make or break one’s retirement. But I believe that COLA riders can often be very inefficient and costly. There are generally two kinds of COLA increases you will see, the “level” and the Consumer Price Index. Level increases are usually a predetermined rate anywhere from 1-6% each year that is agreed upon. It does not change at all during the payout period. It can be simple or compound interest; however, you will benefit more from compound interest.  The alternative is using the inflation number released by the Bureau of Labor Statistics. They use the Consumer Price Index to come to this number and the average rate of inflation over the last 60 years has been 3%. The main way a COLA rider will affect your annuity is your first few payments will be lower as the insurance company must “make up” the amount that needs to be added. Along with this payout adjustment, COLA riders tend to be quite expensive. As your retirement costs increase due to inflation it is better to use your investments as a way to outpace inflation rather than a rider. However, for those comfortable with the fees, this rider could be a valuable way to maintain their retirement standard of living regardless of inflation.