An annuity income rider is typically an additional feature that can be added to an annuity contract in order to provide a guaranteed minimum withdrawal amount that is independent from the annuity's contract value. They are more commonly found on indexed and variable deferred annuity contracts than with traditional fixed annuities. Annuity income riders can only be exercised prior to annuitization, the point at which the contract matures and the contract value is paid out.
How does an annuity income rider work?
A person buying an indexed or variable annuity cannot know how much their contract will grow over time because markets fluctuate. To guarantee a minimum withdrawal amount, they may have an additional option to add an annuity income rider when they first purchase their annuity, or at some point in the future, depending on the contract.
The rider establishes a "benefit base" that is calculated separately from the annuity contract's value. This benefit base is calculated using one of a variety of different guaranteed growth features, depending on the contract. The insurance company takes a periodic fee from the contract value to pay for the rider.
The benefit base may have a guaranteed growth feature for a certain period of time before income begins under the rider. Once the annuity owner initiates income, guaranteed growth of the benefit base may end, depending on the rider. Withdrawal amounts are usually calculated as an annual percentage (specified in the contract) of the benefit base.
Income riders are designed to provide a guaranteed minimum income for the rest of a person's life.
Not all annuity income riders are the same, and investors should consider several factors when choosing one:
Roll-up rate. If included, this is the guaranteed rate at which the benefit base grows, as specified in the contract.
Withdrawal rate. You may not want to look at just the roll-up rate when calculating your payout. The withdrawal rate is the percentage of the benefit base available for withdrawal annually under the rider.
Roll-up period. This is the period for which the insurance company guarantees the roll-up rate will be applied to the benefit base.
Bonus. Some annuity income riders provide a significant one-time increase to the benefit base. This may occur upon purchase of the rider or after a specified waiting period.
Cost. The fee drawn from the annuity's contract value to pay for the annuity income rider will decrease the annuity's contract value over time, so it is essential to evaluate this fee.
Carrier rating. It is crucial to select a reputable insurance company with a high rating from the financial rating agencies. Because income riders are designed to provide a guaranteed lifetime income, you want the insurance company to survive for at least as long as you do.
Annuity income rider facts
Benefits of annuity income riders
Annuity income riders can provide benefits to contract holders when used as part of a well-planned retirement strategy:
A guaranteed income for life. Annuity contract holders are unsure of their eventual contract value-and therefore their withdrawal amounts. Purchasing an annuity income rider can help ensure that you receive a guaranteed income stream in retirement, no matter how long you live.
Options to transfer to a spouse. Some income riders can cover couples, meaning that if one spouse dies the other can receive a payout for as long as he or she lives. This may help provide peace of mind that a person's loved one will be financially secure.
Disadvantages of annuity income riders
It is important to understand the limitations of an annuity income rider when planning for your retirement income.
Annuity income riders provide no principal growth. Annuity income riders create a separate value (benefit base) that is used for the sole purpose of calculating withdrawal amounts under the rider. The benefit base does not represent an available lump sum that can be withdrawn from the contract. Furthermore, it can be reduced by certain withdrawals not covered under the rider. It is important to be clear on what the benefit base is and is not.
Fees can accumulate. There are a wide variety of riders, and costs can increase depending on the options you choose. For example, riders covering a couple are usually pricier than riders insuring one person. These fees decrease the contract value of your deferred annuity and can be significant over time.
Choosing the right annuity income rider for you
When choosing an annuity income rider, ensure that you understand all of the nuances involved. Rather than just looking at the roll-up rate, think about the desired payout that you're hoping for, that means evaluating the withdrawal rate.
Consider how long you may need to use the annuity income rider and whether or not it is transferable upon death. Clauses like these will affect the annual fees charged to the contract, so look for a healthy balance between flexibility and cost in any annuity income rider.
Annuity income riders are a complex topic and are worth discussing with professionals. To learn more, read our guide to annuities.