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.