Lifetime Income Through Annuities: Everything a Retiree Should Know

There are two ways to generate guaranteed lifetime income through annuities, and it’s important to understand their differences.

The standard, simple way is to buy a single premium immediate annuity (SPIA) or a deferred income annuity (DIA).

An income rider simply is a feature that you add to the annuity contract. Remember that in a fixed-indexed annuity, your account earns interest based on the performance of the index or indexes tracked for the account.

Under the income rider, the insurance company will pay you a lifetime income stream beginning at some point in the future.

You’ll know what the income stream will be, because it’s written in the annuity contract. Having the income rider is optional and so is taking the lifetime stream of income.

In most income riders, you don’t have to convert the account to a stream of lifetime income. You have that option but also can decide that you want to take your account balance and do something else with it.

In some annuity riders, you have the option to begin the income stream for a few years and then stop it and defer income for a few more years.

The insurance company charges a fee for the income rider that is deducted from your account balance each year, even if you never exercise the option to receive the income.

The trick is that when an annuity has an income rider, you have to be aware of two account values. There’s the accumulation value of the annuity, or the cash value.

That’s your original investment, plus the interest that is credited to it each year. This is the money you can walk away with if you decide to withdraw from the annuity (after any early withdrawal fees).

The income rider fee is deducted from the accumulation value each year. But the guaranteed income from the rider is based on a different value.

The insurance company takes your original investment and adds a guaranteed growth percentage each year.

The growth percentage is set in the contract. This isn’t real money that you can walk away with. It is a phantom account that is used only to calculate the guaranteed lifetime income if, in the future, you elect to exercise the income option.

The benefit of this method is that you know when purchasing the annuity exactly how much the guaranteed lifetime income will be if you exercise the income option.

You can see how the first income payment will change based on how many years you wait to exercise the income option. The guaranteed growth percentage that’s added to the phantom account each year won’t be the same amount by which your accumulation value grows.

It might be significantly higher than the interest you earn. The important number is the future guaranteed annual income, not the phantom growth rate or value of the phantom account.

A fixed-indexed annuity or variable annuity with an income rider is best used when you believe you’ll want guaranteed lifetime income in the future but not for years.

If you want guaranteed income now or in the next few years, a SPIA or a DIA is likely to give you the highest income.

When the income need is farther in the future, a fixed indexed annuity with an income rider might be the better choice, generating higher income than the alternatives.

In addition, you have the potential of earning a greater amount of interest on your account over the years.

You might run into the terms guaranteed minimum income benefit (GMIB) and guaranteed minimum withdrawal benefit (GMWB).

The GMIB gives you a guaranteed annual income once you exercise the rider.

The annual income is based on the phantom account value. The GMWB guarantees you can withdraw up to a stated percentage of the contract value every year for the rest of your life.

Some GMIBs base the guaranteed annual income on the highest accumulation value of your annuity.

But these will start the guaranteed lifetime income at a lower level than a GMIB that uses the phantom account value or starting account value. Some income riders also come with confinement care benefits, which are benefits paid if you move into a nursing home or similar residence.

Don’t confuse these provisions with long-term care insurance policies or with the long-term care benefits that can be added to some annuities and permanent life insurance policies.

They’re not nearly as robust. The confinement benefits should be considered only as supplemental benefits to other long-term care plans you have or the only option for people who don’t qualify for long-term care insurance.

You should work with an unbiased expert before buying a FIA or other contract with an income rider. To that end, I encourage you to become a full member of Retirement Watch, which offers access to a wealth of information on fixed-indexed annuities – including research from several trusted experts I’ve worked with for more than a decade.