Guaranteed Lifetime Withdrawal Benefits
Everyone needs to know this is just like having social security except with a residual balance. With social security, all the money you put into it is gone, unless your spouse collects a portion of the payments.
With an annuity you can add a guaranteed income feature that acts just like social security. Buy the annuity and for every year you wait to collect income, the payment amount increases by a certain percentage. The difference being that if you or you and your spouse pass away before all the money has been spent then your heirs collect the remainder value with an annuity.
Monthly income is the only thing that social security and income annuities have in common. The reason I bring this up is because most people see something like the big bonuses and grand interest credits and don’t realize what it means. Many think that it’s nothing more than a 25% bonus and a guaranteed 7% per year, or something similar. There are several variations to this so my goal is to explain how to evaluate these because a lot of advisors and consumers focus on the wrong thing.
First I need to explain the difference between income value and account value for those who don’t know the difference. The account value is equal to the money you put in the contract, plus interest earnings each year, less fees for additional benefits like an income rider. Many people either on the professional or consumer side mistake these two values and it has led to a lot of ill-informed decisions. The account value is the amount of money you would have if you cancelled the contract and walked away. The income value, also known by many other similar names, is nothing but a bookkeeping value used to calculate guaranteed lifetime income.
There are three major variables to consider when trying to determine which contract is best and everyone of them has to be accounted for. Initial bonus, rollup rate and payout rate are all important factors.
Bonus- An initial boost to the premium that is most often only credited to the income value. Too many people think that the insurance company is just handing out free money but nothing could be further from the truth. Lots of agents use this feature and little else to sell their favorite product. It’s sad but true.
Rollup Rate- This is the amount of guaranteed annual increase to the income value. For each year you wait, the income value will increase by a set percentage. The longer you wait, the bigger the income value gets. Many people mistake this for an annual growth rate on their account value and opportunistic agents might not explain otherwise. I can’t even tell you how many hundreds of people who have learned otherwise by finding this website, sometimes years after they bought an annuity with the wrong expectations.
Payout Rate- When you decide to take income, all the bonuses and annual rollups are factored in and you’ll get a certain percentage of that number via lifetime income payments. That’s the payout rate and in most cases has been given the least amount of consideration.
You have to put all three together to see which contract actually has the highest payout. Like I always say, if you’re going to use an annuity then go for the strategy that gives you the most in return. A contract with a big bonus might have a low payout rate. In comparison you might see a contract with no bonus, a high rollup rate and healthy payout rate that offers more income. No single option is right for every scenario. It’s going to depend on who you are and what you want out of it.
Let’s look at a quick example to illustrate the point. These are not real contracts but it’s a good representative example of the different types of annuities available. To make it easy I’m going to use simple interest and basic math. We’ll use $100K as the example premium but no age or specific client details need to be used because we are looking only at the general idea.
Contract #1: 20% initial bonus, 5% annual rollup and 4% payout
Income Value after 1 year is $125K, creating $5,000 annual lifetime income
Income Value after 2 years is $130K, creating $5,200 annual lifetime income
Contract #2: 0% initial bonus, 10% annual rollup and 5% payout
Income Value after 1 year is $110K, creating $5,500 annual lifetime income
Income Value after 2 years is $120K, creating $6,000 annual lifetime income
Clearly contract #2 provides a better income stream but there are those who favor a big bonus. It seems obvious which is the best choice but believe me, lots of people can’t get past the bonus. One of the preferred contracts I use has neither a bonus or a rollup rate. Instead the company just aggressively increases the payout rate for every year of deferral. I’ve shown it to several people who couldn’t get past the fact that it didn’t have a bonus. Why does a bonus matter if it doesn’t give you more actual money?
I guess I’ll never know why some people make the decisions they do but for those of you who care, I’m trying to make it clear. Guaranteed Lifetime Withdrawal Benefits have been around for almost 20 years. It’s a good solution to the retirement crisis because insurance companies are the only institutions who can offer a guarantee like that.
Is it the best option? In some cases, yes, but there are plenty of instances where alternatives for protecting assets and creating retirement income can be done much more effectively with a different strategy. Those who have been around for a while know that I promote a different strategy and have been doing so for a long time. That doesn’t mean that guaranteed income isn’t a good deal for you. But you should do your research and learn how to evaluate options at the very least. I’m here to help if anyone needs it.
Next week I’ll go back to another case study where the alternative makes more sense. Enjoy your weekend!