In a past article, we briefly touched upon the basics of annuity riders; the good and the bad.
An annuity rider is an optional add-on to your annuity contract that provides additional benefits beyond the basic annuity contract. Annuity riders can be confusing, and it’s important to understand the different types of riders available to you. In this comprehensive guide, we will explore the different types of annuity riders and how they can benefit you.
We previously discussed that almost all riders could be categorized into either Income Riders, Death Riders, or Care Riders. To simplify comprehension and comparison, this guide categorizes the top annuity riders into three buckets.
Income riders are riders that help either boost or enhance your income or income-earning capacity. These riders are useful for generating additional income while you are alive.
The following are the top income riders that you can get with an annuity:
Guaranteed Minimum Withdrawal Benefit (GMWB) Rider
A GMWB rider is a popular annuity rider that guarantees a minimum withdrawal amount for a specified period of time. This rider ensures that you will receive a guaranteed withdrawal, regardless of the performance of your annuity’s underlying investments. During a market downturn, this rider preserves the highest value of your annuity, commonly referred to as the “benefit base” or “high-water mark,” while enabling underlying investments to increase in value during an up market.
Let’s briefly understand this rider with an example:
Suppose John is 60 years old and wants to purchase a variable annuity with a GMWB rider. He invests $200,000 in the annuity and chooses a GMWB rider with a guaranteed withdrawal rate of 5% per year. This means that he is guaranteed to receive at least $10,000 per year in retirement income for the rest of his life, regardless of how the annuity’s underlying investments perform.
Suppose after a few years, the annuity’s underlying investments perform well, and John’s account value increases to $250,000. Under the GMWB rider, he can still withdraw $10,000 per year even though his account value has increased.
On the other hand, if the annuity’s underlying investments perform poorly and John’s account value decreases to $150,000, he can still withdraw $10,000 per year. The GMWB rider ensures that John will always receive the guaranteed minimum income amount specified in the rider, regardless of the account’s value. Retirees who prefer not to annuitize their accounts may find GMWB to be an appealing alternative. In Annuitization, annuity holders typically relinquish their account balance in exchange for a guaranteed monthly payment for the remainder of their lives, which is not the case here.
It’s important to note that GMWB riders typically come with fees ranging from 0.5%-2% of the account value per year. When evaluating the overall value of the product, one should consider these fees, which diminish investment returns.
Guaranteed Minimum Income Benefit (GMIB) Rider
A GMIB rider guarantees a minimum level of income from your annuity, regardless of market performance. In contrast, a Guaranteed Minimum Withdrawal Benefit (GMWB) Rider is another type of insurance policy rider that guarantees a minimum level of withdrawal amounts to the policyholder, regardless of market conditions or fluctuations in the value of the underlying investments.
Let’s briefly understand this rider with an example:
Let’s say you purchase an annuity policy with a GMIB rider that guarantees you an annual income of $6,000 per year for life, regardless of the performance of the underlying investments. If the investments in your annuity account lose value and your actual account value falls below the guaranteed minimum income level, the insurance company will make up the difference and ensure that you receive your guaranteed income amount of $6,000 per year.
Another GMIB example is a feature that guarantees the annuity benefit based on the investment account’s highest attained value.
This rider can provide peace of mind by ensuring that you will have a guaranteed income stream in retirement, even if your annuity’s underlying investments perform poorly. Also, note that this rider has a cost that can erode your annuity’s investment growth.
Adding to it, these riders are generally complex, and the terms vary for different insurance companies.
Guaranteed Minimum Accumulation Benefit (GMAB) Rider
A GMAB rider guarantees that your annuity will grow to a certain level, regardless of market performance.
With a GMAB rider, the insurance company guarantees that the policyholder’s account value will not fall below a certain level, even if the underlying investments perform poorly. For example, if the policyholder invests $100,000 in a variable annuity contract with a GMAB rider that guarantees a minimum accumulation value of $120,000 after five years, the insurance company will make up the difference if the actual account value falls below $120,000 at the end of the five-year period.
The key difference between GMIB and GMAB is that the GMAB Rider guarantees a minimum level of account value or investment return, while a GMIB Rider guarantees a minimum level of retirement income. In other words, a GMAB Rider is typically geared towards individuals who want to protect their investment principal, while a GMIB Rider is geared towards individuals who want to ensure a reliable income stream during retirement.
This can be useful for those who are concerned about the volatility of the stock market but still want to benefit from the growth potential of an annuity. Again, it’s important to note GMAB riders typically come with fees ranging from 0.5%-2% of the account value per year. When evaluating the overall value of the product, one should consider these fees, which diminish investment returns.
Guaranteed Lifetime Withdrawal Benefit (GLWB) Rider
By adding a guaranteed lifetime withdrawal benefit rider, you can receive an annual income for the remainder of your life without the need to convert any of those payments to an immediate annuity (traditional annuitization). It may sound similar to the GMIB that we discussed previously. However, there is a fine line of difference between both. GLWB Rider typically offers greater flexibility in terms of when the policyholder can start taking income, while a GMIB Rider often requires the policyholder to begin taking income at a specified age or within a certain time frame.
Inflation-Protected/ Cost of Living (COLA) Rider
An inflation-protected rider ensures that your annuity’s payments will increase over time to keep pace with inflation. This can be important for those who are concerned about the impact of inflation on their retirement income.
Let’s consider an instance where John purchases an immediate annuity with a COLA rider. The annuity provides him with a guaranteed income stream of $10,000 per year for the rest of his life. The COLA rider provides an annual increase of 3% to his income payments. If inflation rises by 3% in a given year, John’s annuity payments also increase by 3% to $10,300 next year. If inflation rises by 2% in another year, John’s annuity payments will increase by 2% to $10,506 the following year.
Market Value Adjustment (MVA) Rider
The Market Value Adjustment (MVA) rider allows the policyholder to receive higher or lower surrender values, basis current market conditions. This rider can be beneficial for individuals who want to take advantage of market fluctuations.
Return of Premium Rider
The Return of Premium rider is an optional feature that guarantees that the policyholder’s premium contributions will be returned to them if they cancel their annuity contract before the end of the surrender period. This rider provides peace of mind to the policyholder and ensures that their money is not tied up indefinitely.
Generally, it’s inadvisable to choose this rider since the rider cost has already factored in associated benefits in most situations.
Commuted Payout Rider
With a commuted payout rider, the annuitant can receive a lump sum payout of the remaining annuity payments, which is calculated based on the present value of future payments. This can be useful if the annuitant has an unexpected expense or investment opportunity that requires a significant amount of cash or if the annuitant’s financial needs change over time.
As an illustration, suppose that Joe purchases an immediate annuity with a commuted payout rider. The annuity provides him with a guaranteed income stream of $2,000 per month for the next 20 years. After 10 years, Joe decides that he needs a large amount of cash to pay for his child’s college tuition. He can choose to exercise the commuted payout rider and receive a lump sum payout of the present value of the remaining 10 years of payments, which would be calculated based on the annuity’s interest rate, the remaining payments, and other factors.
Death Riders are riders that help you leave a legacy after you are gone. It may be in the form of a lump sum payment to your beneficiaries or in a series of payments.
The following are the top death/riders that you can get with an annuity:
Death Benefit Rider
Death benefit riders ensure that your beneficiaries receive a minimum guaranteed amount if you die while your annuity is active. This benefit may be fixed dollar amounts, the annuity’s value percentage at annuitant’s death time, or another formula agreed upon. This can provide peace of mind for those who are concerned about leaving their loved ones with unexpected expenses.
Let’s say, for example, Sarah purchases a deferred annuity with a death benefit rider designating her spouse as the beneficiary. The rider specifies that if Sarah dies before the annuity commences, her spouse will receive full premium paid plus interest. In case of Sarah’s death after annuity commencement, the rider specifies her spouse receives a percentage of the annuity’s value.
Enhanced Death Benefit Rider
An enhanced death benefit rider provides a higher death benefit if you pass away during a specified period of time, such as the first 10 years of your annuity. This can be useful for those who are concerned about leaving a legacy for their loved ones. This rider allows the annuitant to designate one or more beneficiaries who will receive a benefit upon the annuitant’s death. This benefit may be higher than the standard death benefit provided in the annuity contract and is often based on a specified percentage of the annuity’s growth or market value over the term of the contract.
Let’s assume, hypothetically, that John purchases a variable annuity with an enhanced death benefit rider. He designates his children as the beneficiaries, and the rider specifies that if John dies, his children will receive a benefit equal to the greater of the annuity’s account value or the sum of all premiums paid plus a specified percentage of the annuity’s growth over the term of the contract.
Long-term Care Riders
Long-term care riders are the riders that can help you in the form of enhanced income or expedited payout to protect you from the high cost of long-term care. These riders are new in the annuity world, and currently, not all annuity company offers long-term care riders.
The following are the top death/riders that you can get with an annuity: n
Long-Term Care (LTC) Rider
An LTC rider provides coverage for long-term care expenses. Long-term care riders enable the annuitant to use a part of the annuity’s value to cover qualified long-term care expenses. Long-term care expenses could include nursing home care or in-home care. Typically, the rider specifies a daily or monthly benefit amount that the annuitant can use to pay for these expenses. This rider offers control over investments and safeguards retirement savings from high long-term care expenses, thus, making it valuable.
Let’s assume that Bob purchases a deferred annuity with a long-term care rider. The rider specifies that if Bob becomes unable to perform at least two activities of daily living or is diagnosed with cognitive impairment, he can access a portion of the annuity’s value to pay for qualified long-term care expenses. The rider enables the annuitant to use a $200 daily benefit to pay for nursing home care or in-home care.
Terminal Illness Rider
A terminal illness rider provides the annuitant with access to a portion of the annuity’s value before their death in the event that they are diagnosed with a terminal illness with a significantly reduced life expectancy of less than a specified number of months (usually 12 months or less) without incurring surrender charges or other penalties.
To better understand, let’s suppose that Sarah purchases a deferred annuity with a terminal illness rider. The rider specifies that if Sarah is diagnosed with a terminal illness and has a life expectancy of 12 months or less, she can access a portion of the annuity’s value without penalty. To cover medical or other expenses related to her illness, the rider allows her withdrawing upto 50% of annuity’s value.
Impaired Risk Rider
An impaired risk rider provides the annuitant with higher payout rates if they have a medical condition or history that may shorten their life expectancy. An annuitant with impaired risk rider may receive higher payout rate based on their health status than a standard contract.
In the event of disability or job loss, disability riders and unemployment riders can raise your annuity payout amount for a fixed duration. With a disability/unemployment rider, the annuitant can receive a portion of their annuity’s value if they become disabled/unemployed and are unable to work. The rider usually outlines a monthly withdrawal percentage of the annuity’s value for income replacement during disability/unemployment.
As an instance, let’s assume that Jane purchases a deferred annuity with a disability/unemployment rider. The rider allows using a portion of the annuity’s value for income replacement if Jane experiences disability/unemployment. The rider allows her withdrawing upto 3% of the annuity’s value monthly to cover living expenses during the disability/unemployment period.
The disability/unemployment riders provide the annuitant with added protection in the event of a disability or job loss, allowing them to access their funds to cover living expenses without having to surrender the annuity or pay surrender charges.
Annuity riders can be an essential component of retirement plans as they can provide added benefits beyond basic annuity contract. Individuals can purchase these riders as add-ons to the annuity contract for an extra fee. The selected rider can provide diverse benefits, including income, death, and long-term care benefits, based on the type of rider.
It’s essential to understand the different types of riders available to you and how they can benefit you in retirement. For example, a guaranteed minimum income benefit (GMIB) rider can provide a guaranteed minimum income stream for life, even if the underlying investments in the annuity do not perform as expected. A long-term care rider can provide coverage for long-term care expenses, which can be a significant expense for retirees.
Selecting the appropriate annuity rider can be difficult, and a financial advisor can help make informed decisions about retirement planning. By assessing retirement goals, risk tolerance, and financial situation, a financial advisor can help choose suitable annuity riders. They can assist in comprehending the expenses and trade-offs linked with each rider and their alignment with your financial plan.