The Annuity Income Rider

Every so often investments change in a dramatic fashion. It may be due to the fluctuating economy at that time, new trends, or just a new idea. Regardless of how they come about, the benefits to the consumer is what ends up being most important. And knowing when and when not to use these new features, and whom they are most suitable for, is vitally important for any investor.

So how would a layman interpret the basics of this new Annuity Income Rider?

Let's start off with a short re-cap on the basics of a Fixed Indexed Annuity. This is crucial to understanding the income rider. A Fixed Indexed Annuity typically guarantees an investors principal over a certain period of time. The guarantees are based on the insurance company's financial strength, reserves, re-insurance, and other safety features. The interest earned or credited to this investment is based on how a particular index performs, such as the S&P 500.

So let's now address the index returns. Picture an investment that is again, backed by an insurance company, where money is always held with the insurance company and never invested directly in any stock market index. The returns of that index is what the company will use to calculate an investor's interest, up to a maximum called a CAP.

Quick example: The S&P 500 returns 10% over a 1 year period subject to an 8% Cap or maximum. What would be an investor's interest that would be credited to their fixed indexed annuity? 10% return with a maximum or Cap of 8%, so the answer is 8%.

Now let's add another feature called a Participation rate. The participation rate is how much you participate in any given return. Here's an example: The S&P 500 has a 10% return for a 1 year period subject to an 80% participation rate. What is the interest credited? 10% x 80%=8%.

Now adding the Cap and Participation rate in an example: S&P 500 returns 10% subject to an

80% participation rate and a 7% Cap, what is the amount of interest credited? 10% X 80%=8%,

with a maximum of 7%, so the interest credited is 7%.

Let's call this above example the "base annuity" which also comes with a surrender fee schedule, some liquidity features and other normal fixed annuity provisions.

Now that you have a very basic understanding of one way interest is credited to a Fixed Indexed Annuity, let's add the features of the Income Rider.

A typical income rider will be in addition to the "base annuity". A typical income rider will have a fixed rate of growth as long as you use that growth for a future income. This is the big caveat, so I'll repeat that: As long as you use that growth for a future income. You cannot, in most cases, access the growth in an income rider. They only show you the growth and returns on the income rider for you to simply calculate your future income. All access to growth and principal, etc. comes from the "base annuity" side.

Again, the best way to illustrate this is by an example: Picture two halves of one sheet of paper. On the left half is your "base annuity" with its participation rates, surrender fee schedule, Caps, liquidity provision and all other normal fixed indexed annuity features. Now picture on the right side a fixed 7% return on your money until retirement age, as long as you use this growth to provide you with a future income.

Let's now go out 15 years into the future. Whichever side has performed better over all of these years is the side that you can elect to take an income from. If your income rider side at a fixed 7% is worth more than your "base annuity" side, this is the side you can elect to take your income from and visa versa.

The income you receive is based upon age brackets, for example: age 60-69 equals a 5% lifetime payout, age 70-79 equals a 6% lifetime payout, etc...

To clarify, there are two different issues with two different rates. You have your growth rate, which on the income rider example I'm using 7% growth on the money. Then you have your income rate which provides retirement income. This income rate is based on age brackets mentioned above. Just be aware of the two distinct rates for growth and income.

This lifetime Income Rider payout will continue despite if your base annuity has poor interest credited to it. Obviously if you make withdrawals from your base annuity that would affect your future income. Or if your base annuity has spectacular growth and would provide more than your income rider side, you can then elect to take the higher income.

There are many more features to an income rider, however this example should give you a basic understanding. The income rider is simply a number on a sheet of paper which shows

a growth rate in which you cannot access, but use for future income. Your base annuity features is where you would access principal, make withdrawals subject to a surrender fee schedule, subject to any IRS penalties if they may apply, subject to any taxes if they may apply, etc.

This rider may be suitable for those people looking for a future income on an investment that has guarantees, safety features and tax deferred growth. As always, consult an annuity expert who understands your specific situation to ensure your suitability. There may be fees associated with incomer riders.

Dave Coyman, also known as "Mr. Annuity", delivers value packed videos containing money saving information and other annuity pros and cons that you need to know to avoid costly investment mistakes.