According to recent sales statistics, most variable deferred annuities and fixed index annuities are sold with income riders and are becoming more common for traditional fixed annuities as well. There is a wide variety of choices available, and it is no secret that no two income riders are created equal. There are a few services emerging that provide advisors with the ability to compare income riders, but they appear to have little or no academic basis underlying the comparisons.
Comparing income riders
At best, current comparison tools provide estimated projections of popular income riders. These tools appear to be designed to determine which income rider achieves the highest dollar amount of lifetime income. This approach could lead advisors to the false conclusion that the income rider that produces the highest dollar amount of monthly income may be best for the specific client’s retirement needs.
There are subjective considerations that should be taken into account in selecting the best income rider. However, the overly simplistic method of comparing the dollar amount of lifetime income payments produced by various income riders would miss three major elements that are necessary in a sound comparison.
Economic value of lifetime income – Consider two single-premium immediate annuities: SPIA No. 1 provides lifetime income of $1,100 per month for the life of a 65-year-old male with no minimum guarantee on the number of income payments to be made. SPIA No. 2 provides a lifetime income of $1,000 per month for the lifetime of the same 65-year-old male with payments guaranteed for a minimum of 20 years.
Which SPIA has the greater economic value? If you guessed SPIA No. 1, you would be wrong. The economic value – in this example, the amount of cash the client would need to make the purchase – of SPIA No. 2 is about 1 to 5 percent higher, depending on the carrier, than the economic value of SPIA No. 1, even though SPIA No. 1 produces a dollar amount of payment that is 10 percent higher than SPIA No. 2.
Legacy potential - For a client whose needs encompass both guaranteed lifetime income and leaving a legacy, two different income riders that provide identical amounts of income may have dramatic differences. This is due to two effects: total fees and potential performance.
Total fees: Most income riders levy an explicit fee that is charged against the account value of the annuity. In addition, certain annuity types may charge other fees unrelated to the income rider. The total fee charged has a direct impact on the net performance of the annuity and, thus, on potential legacy values.
Potential performance: Different annuity types have differences in potential performance. For example, the performance of variable annuities is based on the combination of equity market performance, including reinvested dividends, and bond market performance. The credited rates on fixed indexed annuities are based on equity market performance, excluding reinvested dividends; there may be limits, such as participation rates, spreads or caps, on how much of the equity market performance is incorporated. Fixed annuity credited rates are typically based on bond market yields, less a spread. Thus, different annuity types cannot be reliably compared without accounting for these differences.
Effective depletion rate - The pace at which the account value is consumed by total fees and monthly withdrawals has a direct effect on the economic value of the overall annuity package. After all, if the reason a consumer purchases an annuity with an income rider, rather than annuitize, is due to the benefit of ongoing access to account values, it follows that the faster those account values are consumed, the less the relative economic value would be to the client, all other things equal.
Clearly, what is needed is a sound model for comparing annuities with income riders, regardless of the type of annuity the income rider is placed. Such comparison models can be constructed by professionals equipped with the technical skills to account for the three primary factors.
In part two, I will address the benefits of using an effective model for comparing annuities with income riders.
For more on annuity riders, see:
Garth Bernard is the president and CEO of the Sharper Financial Group. He has over 25 years of experience in the design, marketing and pricing of life insurance, fixed annuities, fixed indexed annuities, MVA annuities, variable annuities, immediate annuities, deferred income annuities and immediate variable annuities. He may be reached at firstname.lastname@example.org.