Understanding Annuity Riders
Annuities have been long marketed as a reliable solution for a worry-free retirement. In fact, they’re often marketed as an option to guarantee certain benefits, like a specific rate of return, or death benefit for your beneficiaries. Annuity guarantees can vary from contract to contract and often times you can modify your contract by adding a “rider.” A rider is an optional addition to the standard annuity agreement. While they can provide certain benefits and additional security, it’s important to note, they don’t come without extra fees that could reduce the overall amount you receive from your annuity over time.
While riders can take various forms, they generally fall into two categories: living benefits and death benefits. Some of the most attractive features of annuities, such as guaranteed monthly income and lifetime payments, are not included in standard annuities without annuitization. While living and death benefit riders may make you feel safer, they may not necessarily help you reach your long-term financial goals.
Living Benefits
Guaranteed Lifetime Withdrawal Benefit (GLWB)
The GLWB provides the annuitant with income for their entire life, based on a percentage of the annuity's principal. Even if the principal amount is depleted, the annuitant continues to receive this income. While the inclusion of a guaranteed growth rate may initially seem appealing, it primarily affects the calculation of the annual withdrawal amount from your own funds. It's important to be aware that these guarantees can come at a significant cost, as the fee for this type of rider is added to the other fees charged by the annuity provider.
Guaranteed Minimum Income Benefit (GMIB)
GMIB riders, common in variable annuities, protect against underperforming investments by ensuring a guaranteed income stream throughout the annuitant's life. The potential downside is that you forfeit your principal balance after a set period, usually a certain age.
The rider tracks two balances: the “cash value” based on investment performance, and a virtual balance that grows annually. At annuitization (when you turn on the income stream), payments are based on the higher of these balances. These separate accounts come with expenses like transaction costs and fees that can eat into your investment returns. GMIB riders have strict requirements, conditions, and extra fees. They may limit investment choices and reduce principal growth, leading to lower income.
It’s important to note that some riders require an irreversible exchange of funds for periodic payments from the annuity provider. T
Guaranteed Minimum Accumulation Benefit (GMAB)
GMAB riders attempt to protect the annuity’s value from market fluctuations. They provide a minimum guaranteed value, usually equal to the total amount of premiums paid into the policy., in case the annuity’s value drops below a specific amount after so many years.
For example, after a 10-year waiting period, if market fluctuations result in the value of the contract falling below the total premiums paid, the insurance company would increase the value to match the contributions made.
Guaranteed Minimum Withdrawal Benefit (GMWB)
GMWB riders offer assurance to annuity owners that they can take money out of the policy, even if the cash value has dipped below the initial investment. The withdrawals can be taken monthly, quarterly, or annually for a predetermined period, typically over the term of the contract, or the initial investment is recovered. This rider typically incurs an additional annual fee.
These withdrawals are typically subject to a fixed annual amount and are not adjusted for inflation. As a result, the purchasing power of the payments is likely to diminish over time.
Death Benefits
Basic Death Benefits
This ensures that upon the annuity owner's death, the insurance company will pay the beneficiary at least the amount of the contributions made before annuitization. If the policy has already been annuitized, only the remaining unpaid payments may be passed on to the beneficiary.
Enhanced Death Benefits
With enhanced death benefit riders, the insurance company increases the annuity's value on the anniversary date if specific growth requirements are met.
Enhanced death benefits come in various forms and involve different fees. Insurance companies determine the beneficiary's transferable value based on measures such as the highest account value on the anniversary date, highest monthly account value, or highest quarterly account value. Some enhanced death benefits even include roll-up rates for specific periods, similar to an income rider.
These benefits typically come into effect only if they exceed the annuity's current value. If the annuity's value is already higher than the death benefit at the time of the annuity owner's death, these benefits would not apply.
It's important to note that death benefit riders cease to exist once annuitization takes place. Most annuity contracts require annuitization when the annuity owner reaches a certain age. However, it's crucial to remember that after annuitization, there is no death benefit available.
Tax Consequences to Death Benefits
When your beneficiaries inherit gains from a non-qualified annuity, those gains are subject to taxation at ordinary income tax rates. This is because dividends, interest, and capital gains earned within the annuity are not taxed until they are withdrawn. For income tax purposes, gains on inherited non-qualified annuities are considered income when received by the beneficiary. If the beneficiary opts for a lump sum payment, taxes are owed on the amount exceeding the original cost basis, while the original cost basis itself is excluded from taxable income. In the case where the beneficiary chooses to receive periodic distributions, the portion of each payment derived from accumulated earnings is taxable, while the portion stemming from the original premium cost basis is not subject to taxation.
Adding riders to your contract entails certain expenses. In addition to the rider fee, there are underlying charges associated with the base contract and other costs that may represent a fraction of a percentage of your account value annually. Although these fees alone seem insignificant, when combined together plus the cost of the underlying investments, it could limit the growth of your investments. Furthermore, some annuity contracts do not permit the addition of riders once the contract is issued; they can only be included during the initial setup of the annuity.
While riders may seem appealing, it’s crucial to consider the expenses associated with any riders and have a clear understanding of the total fees involved. Unfortunately, many investors fail to thoroughly research and evaluate the cost of annuity products before purchasing. This oversight can have detrimental effects on their financial situation and ability to reach their financial goals.
"Fisher Investments." Fisher Investments, Personal Wealth Management, Your Financial Goals, Grow Your Wealth, Asset Types, Annuities, Riders. Accessed May 25, 2023. https://www.fisherinvestments.com/en-us/personal-wealth-management/your-financial-goals/grow-your-wealth/asset-types/annuities/riders.
