Reduce risk, add an income rider: deferred fixed index annuities, already great vehicles for retirement income growth, get even better when clients add an income rider, providing an alternate income base and an interest rate hedge.
Retirement planning is all about having a high enough income base to generate sufficient independent retirement income to sustain clients, after they retire, for the rest of their lives. Deferred fixed index annuities have become popular as safe instruments that can grow, without risk of loss, along with selected stock market indexes. The index portion of the total interest paid is based on some percentage (perhaps with caps) of the growth of the selected index. Therefore, we can have higher interest than offered in fixed income instruments with the same level of safety and no risk of market loss.
What about the risk that the deferred fixed index annuity might not give clients, because of poor stock index performance, the income base they were hoping for? An income rider attached to a deferred fixed index annuity can help make sure there is enough retirement in come by creating an alternative income base that can grow by as much as 8% compounded on the initial principal.
Two income base options available
Generally, an underlying income base is created over the years with savings and investment. From the income base, retirees draw the lifetime income they will depend on. A designated percentage of the income base per year (such as 4%) creates the periodic payment of retirement income. Therefore, having the highest income base at retirement is a retirement goal, in order to have the highest possible retirement income.
The principal and future underlying income base in a deferred fixed index annuity grows in two basic ways. First, a minimum fixed interest is paid into the account. Second, additional interest is added when a benchmark stock index goes up. Interest is never taken back, except in the case of early withdrawal. The total of the minimum interest and additional interest paid over the years (the total account balance) becomes the potential income base, unless the balance is removed to be used for other purposes.
Income riders reduce the risk that the total account balance will not create desired income streams at retirement. Paper accounts in deferred annuities increase, so there is a minimum alternate income base at the end of the deferral period. The income rider's growth factor is, depending on the contract, generally from 7% simple interest to 8% compounded interest on an amount equal to the premium paid by the con tract holder. Sometimes an additional amount is added to the premium, paid by the issuer as a bonus.
If the alternative income base created by the income rider would generate higher periodic payments of lifetime retirement income, then the retirement income can be based on that alternative income base instead. Or, after an appropriate period, you can remove the total account balance instead, if you would rather do something else with the money.
Rider provides interest rate hedge
The income rider option has a cost that mitigates the potential ending total account balance after accumulations of minimum and additional index-based interest. In these times of low interest rates (with continuing concerns about the risk of interest rate and inflation increases), the income rider provides an excellent hedge. If stock and bond indexes perform well enough to provide additional index-based interest, then the deferred fixed index annuity has served its purpose. It creates more total interest income than a simple fixed interest instrument provides with current interest rates.
However, if the combination of the minimum interest plus additional index-based interest creates a low total account balance, we can still rely on the minimum growth of the alternative income base through the income rider, and thereby, a minimum lifetime retirement income that helps us deal with inflation.
If the income rider option is taken, the 7% simple or 8% compounded (depending on the policy) growth of the income base can be used at any point in time to begin retirement income. Of course, the annual payments will be less than if one waited until later years to start drawing retirement income.
The cost of the income rider option will reduce the ultimate value of the total account balance. However, the typical contract also provides a premium bonus in return for a long-term commitment. This mitigates that problem, although the premium bonus is also offered when an income rider is not selected. Therefore, at the same time we are hedging the potential results of a higher income base, we are reducing what a total account balance can be by virtue of the cost of the income rider. Nonetheless, if the additional index-based interest paid goes up dramatically because the selected indexes go up, there is still the possibility the total account balance will be the higher income base to choose, despite the cost of the income rider.
Long-term commitment needed
As in any decision about where to place funds for retirement, all the factors must be considered. Deferred fixed index annuities are particularly suited for long-term placement of funds for ultimate payment of retirement income. The commitment has associated costs if an early withdrawal is taken. Nonetheless, a deferred annuity still has options to take out money without penalty for important contingencies. The income rider hedges against the risk that the total account balance will not grow at hoped-for rates.
It is likely that, when preparing for retirement income is the highest priority, the deferred fixed index annuity with an elected income rider can play a role. That role is competitive interest accumulations without market risk of loss and an ability to assure an excellent income base that will pay out for
15th Annual Indexed Annuity Survey
Be sure to check out our 15th annual indexed annuity survey beginning on page 88 for a look at detailed information about a variety of indexed annuity products.
Tampa, Fla.-based The Planning Partners is a joint effort by Rick D. Miller, CLU, ChFC, RHU, left, and Scott F. Barnett, J.D., LL.M., to help clients and agents who want the benefit of 70-plus years of combined experience in individual, family, estate, tax and asset protection planning. They deal with the preservation and protection of family assets.
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|Author:||Barnett, Scott E.; Miller, Rick D.|
|Publication:||Life Insurance Selling|
|Date:||Jun 1, 2011|
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