When offering annuities to clients, many insurance agents and brokers advertise annuities’ ability to offer many “guarantees” on a variety of factors, from account growth to long-term income streams. These guarantees are usually tied to the basic annuity contract as a “rider.” These riders can provide living and death benefit protection and often lead the contract owner to believe the annuity is a better investment than it actually is. Many investors think of annuities as an additional retirement income source, but they may not realize the high cost of any accompanying riders. The fees associated with individual riders could add up to the point where they may negate the benefits of having them. Riders to annuity contracts can generally be split into two types:
Living and death benefit riders come in different forms. This article will focus on some of the most common living benefits riders accompanying annuity contracts.
A GLWB rider can be added to a variable annuity for a fee. The GLWB allows the owner to receive a guaranteed income for life based on a percentage of the annuity’s principal and to continue receiving that income even if the principal is subsequently depleted. This can help ensure the annuity owner has retirement income when it is needed. The GLWB can also include a guaranteed growth rate, but it may not be on the account’s yield. These guarantees can be costly, and the fee for this type of rider is in addition to the other fees charged by the annuity provider.
These riders, also known as living benefits, are more common with variable annuities. GMIB riders are designed to protect the annuity owner in case the investments held by the annuity underperform or don’t grow as anticipated. The rider provides a guaranteed income stream that generally lasts for the life of the annuitant. But the downside is the principal balance is usually forfeited after a set period. For example, this rider might stipulate that 10 years after purchasing the annuity, the annuitant must either sell the annuity for its lump sum value or exchange the lump sum for a lifetime income stream. A GMIB annuity tracks two balances: the actual cash value based on the performance of subaccount investments, and a virtual balance that increases by a defined percentage annually. At annuitization, the payments are based on the higher balance. While this might seem like a great deal, investors should be aware that subaccounts incur expenses tied to maintaining the underlying investments, such as transaction costs and administrative fees.
Although these riders may seem like an easy additional benefit to the annuity contract, many have strict requirements and conditions, in addition to their extra fees. Some of the requirements may include annuitization or requiring the holder to convert the deposited funds into periodic payments by turning the entire principal over to the annuity provider. This decision is usually irrevocable. Also, there may be a waiting period before income can be withdrawn and the annuity owner can receive the full guaranteed living benefits. This waiting period is different from the period during which the holder could be penalized for withdrawing funds prematurely (otherwise known as incurring surrender fees). Waiting periods can be as long as 10 years. Some insurance companies may also limit the growth of these types of living benefits by reducing equity exposure within the annuity. This can severely reduce the growth of the principal in the underlying annuity leading to a lower income amount.
These riders guarantee the annuity holder receives a minimum amount after the accumulation period. This will be either the initial amount invested or any gains since then. Similar to a GMIB, this rider is designed to protect the annuitant from losses in value due to market declines. The GMAB rider usually guarantees the principal or amount originally invested, but it can also guarantee any gains since the beginning of the accumulation period. Often, the annuity provider will require a waiting period of at least 7 to 10 years before the GMAB can be invoked.
These types of riders provide a guarantee, for an annual fee, that the annuity owner can still take a withdrawal, even if the cash value of the annuity falls below the original amount invested. This withdrawal can be monthly, quarterly or annually over a predetermined period, typically over the contract’s term or until the original amount invested in the annuity is recovered. This type of rider will often cost an additional annual fee.
Investors should keep in mind that withdrawals are limited to a fixed annual amount, and generally aren’t adjusted for inflation. This means the purchasing power of the amount received will decline over time because of the eroding power of inflation.
Annuities come with their share of pros and cons. Before purchasing an annuity, there are some important factors for investors to consider.
High fees. Most annuities don’t have a single flat rate fee. In addition to the regular fees charged for the annuity contract, any riders you add to the contract will usually require their own individual fees that get stacked on top of each other. These fees can add up to several percentage points. While a few percentage points in fees may not seem much, the cost can add up over time. This can greatly impact long-term performance, even if the annuity’s investments achieve the same performance as the stock market.
In some cases, particularly with GMAB, GMIB or GMWB, any growth in the account can often negate the value of the living benefits.
Inflation. Inflation is problematic because it erodes purchasing power over time. Fixed annuities—a type of annuity that tends to produce lower returns than others—often won’t protect an investor from inflation. For example, a $60,000 annual payment on December 31, 2018, will probably not be the same as a $60,000 annual payment on December 31, 2038. If we assume annual inflation of 3%, $60,000 received in 2038 will only be able to purchase $33,221 worth of goods and services in 2018 dollars. Annuity providers can provide protection from inflation with a separate rider, but the additional fees might result in the annuity earning far less than inflation—particularly when added to other fees the policy owner may already be paying.
Also, even though GMAB and GMWB riders may help ensure the annuity owner can recoup the initial deposit, inflation generally eats away at the purchasing power of that amount over time. Over just a few years, this can amount to a significant decline in purchasing power.
If you aren’t sure what has been “guaranteed” by your annuity contract or if it has living benefits riders, Fisher Investments might be able to help. We offer annuity evaluation services for qualified prospects. Our team of knowledgeable annuity counselors can review contracts and provide clear, accurate explanations of the benefits they include. We will even get on the phone with the annuity company to clarify any details.