Guaranteed Income Benefits
Good or Bad?
By: Roccy DeFrancesco, JD, CWPP™, CAPP™, CMP™
Copyright 2007, The WPI
As many of you may be aware, some insurance companies who sell Equity Indexed Annuities (EIAs) (also now called Fixed Indexed Annuities), have added a “guaranteed income benefit” rider to their contracts.
I’ve waited a little while before doing a newsletter on this so I could take a look at what’s out there. I’ve now taken that look and thought I would pass along my thoughts.
Like anything in the insurance industry, the insurance companies never lose money and there are positives and negatives to every policy (or in this case EIA). That is no different in this product.
Not everyone who receives my newsletters understands EIAs. To read how EIAs work so you can fully understand this newsletter, please click here to view a short educational PowerPoint presentation.
I thought about the best way to explain this topic and I chose to go with a little Q&A to explain it.
What is a “guaranteed living benefit” (GLB) in the context of an EIA?
A GLB contract “rider” is issued by an insurance company that “guarantees” a regular monthly, quarterly, or annual payment for a client’s lifetime, even if the account balance of the EIA does not support the income stream. Example: suppose you had a client who was 61 years old who invested $100,000 in an EIA with a 5 percent lifetime income benefit rider. If the client activated the rider immediately, the insurance company guarantees a withdraw of $5,000 per year for the rest of the client’s life (no matter how long they live), even if the account balance does not have enough money in it to support the steam of income.
You see these types of riders more often with Variable annuities where there is NO protection on the cash in the annuity.
Question—How much will the company guarantee as an income benefit?
Answer—It depends on the company but a good rule of thumb is 5% if the contract is issued before age 70, 6% before age 80 and 7% over 80 years old.
Question—When does the income benefit kick in?
Answer—When the client requests that income begin (and the value of the EIA on that date will drive the income benefit).
Question—Can the client receive more money from their guaranteed income benefit if the EIA increases in value during the payout phase?
Answer—Yes. It is likely that the guaranteed income benefit will increase if the S&P 500 early on in the payout phase returns more than the income benefit.
Question—Does the client have to “annuitize” the EIA in order to get the guarnateed income benefit?
Answer—No. If clients want to take distributions from the EIA they still can (although this will lower they guaranteed income benefit going forward).
Question—What extra cost is there for the client when this “rider” is added to the contract?
Answer—It depends on the company, but the going rate seems to be around .4% (.oo4) of the client’s annual returns. So, if the client used an annual point-to-point crediting annuity with a cap of 8%, the returns on an annual basis would be minus .4%. If the S&P 500 returned 7%, the client would be credited with 6.6%.
Question—What happens in years where the S&P is negative or returns zero?
Answer—The .4% fee is not charged and instead there is a debit of .4% which is carried over to the next positive year. In the next positive year the .4% will be subtracted from the gains.
Question—Do these types of riders make sense with an EIA which already guarantees that the client will never lose money when the market goes down and where most EIAs lock in investment returns on an annual basis?
Answer—This is a tough one. I tabled this out in an excel spreadsheet and the answer is it depends. If the market returns in the above example average more than 5% a year while the client is receiving annual guaranteed payments, the client would have been better off simply taking withdrawals from the annuity. Why? Because of the .4% fee with the rider. I will talk more about this and break down the numbers in next week’s webinar.
What’s the bottom line with EIAs that have “guaranteed income benefits?”
They should be used if a client who is 60 years old or older and wants to have certainty when it comes to an income stream. If you table them out over the long term, the client will be better off allowing the money to grow each year in the EIA and taking withdrawals (this assumes the average rate of return inside the EIA is higher than the guaranteed rate over the lifetime income period).
Some of these EIAs have other riders which are interesting.
1) Enhanced Death Benefit Rider.
2) Return of premium Rider.
Due to space issues, I do not have time to go over either of these riders in this newsletter.