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February 01, 2012 at 07:00 PM
Despite the continued low interest rate environment, indexed annuity sales continue at near record levels. According to Jeremy Alexander, CEO of Beacon Research, this is at least in part due to “the lifetime withdrawal benefits offered by most indexed annuities.” When living benefits were introduced on variable annuities, the idea was to protect the client’s future retirement income from an untimely bear market. By creating an alternative account from which the client could draw income, the client can have the peace of mind of knowing his or her income is protected. However, the value of an indexed annuity never falls from year to year. The product itself is designed to protect the client’s principal from market volatility. Therefore, putting a living benefit on an indexed annuity is like buying insurance on insurance.
Unlike variable annuity companies, indexed annuity companies don’t have to worry about the policyholder’s account value going down. As a result, they can always offer more generous living benefit terms than a variable annuity. In fact, the current pricing of these riders on indexed annuities guarantees that the policyholder will always have a higher income benefit base than account value.
The graph to the left shows how an indexed annuity might perform for a 65-year-old female who earns, on average, 4.5% per year on an indexed annuity. This also assumes that she bought a living benefit that credits 7% each year to the income benefit base until she begins to receive income via the living benefit at age 80. Finally, it assumes that she receives a 10% bonus on both the account value and the income benefit base.
The red bars represent the $100,000 initial account value growing at 4.5% for 15 years and then declining over time as the $21,245 withdrawals, beginning at age 80, slowly erode its value. The blue bars represent the income benefit base growing at 7%. Since the only purpose of the income benefit base is to calculate the amount of the allowable withdrawal under the rider, it is eliminated from the graph once the income begins. The income benefit base will grow to 303,493, so the annual income payment will be 7% of 303,493 or $21,245 (I left off the “$” sign because an income benefit base has no cash value).
