If your Social Security benefit or pension won’t provide you with enough guaranteed monthly income to keep you comfortable in retirement, an annuity can help.
You can watch the video on this topic further down, to listen to the podcast episode, hit play below, or read on for more…
There are often limited resources for securing guaranteed income in retirement, but if you have or are considering opening an annuity, you may be able to access an “income rider”. An income rider is an additional annuity feature designed to guarantee income for the rest of your life.
In this post, we continue our “Annuities – Why Ever Use Them” series by diving into how a fixed index annuity provides guaranteed income using the income rider.
Our annuities series is a comprehensive guide to this complex product. If you want to learn more about annuities, we encourage you to read the posts on our blog, listen to the episodes on the Secure Your Retirement podcast, or follow the links below to watch them on our YouTube channel:
- Part 1 – Annuities – Why Ever Use Them
- Part 2 – Annuities – Why Ever Use Them
- Part 3 – Annuities – Why Ever Use Them
- Part 4 – Annuities – Why Ever Use Them
Why choose a fixed index annuity? A quick summary
We believe there are three reasons why you would want to add a fixed index annuity to your portfolio. The first is good accumulation. Fixed index annuities accumulate similar to a bond, but with the added benefit of no downside risk. The second is the death benefit, and the third is guaranteed income.
Before we discuss how to get guaranteed income from your annuity, here is some high-level information to help you understand how annuities work, the different types, and why we recommend a fixed index annuity.
- Deferred annuities are either fixed or variable.
- Variable annuities are linked to market investment through buying mutual funds. The rates are often high for variable annuities, and they come with risk. To make a decent return on your variable annuity, you have to overcome these fees and more.
- Fixed annuities have guaranteed principals, meaning you cannot make a loss, which is why we prefer them.
- There are two types of fixed annuity, traditional and indexed – both guarantee your principal.
- The traditional annuity is similar to a CD (certificate of deposit). You give your principal to an insurance company, and they provide a return based on a fixed rate for a number of years.
- With an indexed annuity, your return is linked to an index such as the S&P 500 or the NASDAQ. Even though indexes can fall, your principal is guaranteed, so the worst a fixed index annuity can earn in a year is zero.
- The crediting methods for fixed annuities are based on a point-to-point annual reset. For example, if you open an annuity on January 1st, 2021, you’ll earn your interest on January 1st, 2022.
- If you have a fixed index annuity, your interest will be calculated depending on what strategy you use. This could be a cap or participation strategy. To learn more about caps and participation rates, read our blog post, Fixed Index Annuities: How They Work and Things to Consider, or watch the podcast episode.
Our “Annuities – Why Ever Use Them” series covers many of these points in much greater depth, so if you have any questions about how annuities work, please visit the other articles on our blog.
A fixed index annuity is our recommended option, especially for retirees who need access to a higher guaranteed income.
Why guaranteed income is important in retirement
When planning for your retirement, you want to ensure that you have enough guaranteed income to cover all of your essential income needs. Your income needs fall into one of three categories:
- Essential: anything you need to pay for, e.g., your water bill
- Wants: anything that isn’t necessary but gives you a better quality of life, e.g., vacations
- Giveaway money: for gifting to your children or a charity
We believe that at least your essential outgoings should be covered by your guaranteed income.
Most retirees have two guaranteed income sources, their pension and Social Security. Beyond this, there are limited options to secure guaranteed income. One option is to add an income rider to your fixed index annuity.
The cost of a fixed index annuity income rider
Adding an income rider to your annuity gives you a lifetime income benefit. This is a powerful tool to help you take care of your essential income needs and grant you continued access to your principal. But, if you’re aiming for your highest guaranteed income, you’re going to have a fee.
There can be two different types of fees with an income rider. The first is a clear-cut fee, where the insurance company will charge you a percentage of your principal. This is usually around 1%. The second is a built-in fee, where you won’t be charged directly, but you will see a reduction in return.
How a fixed index annuity income rider works
A fixed income annuity already accumulates money for a death benefit. The income rider income generation is separate from this. Bear in mind that this income value is not lump sum money. If an insurance agent tells you that their annuity can give you 6% growth, this rate is for income purposes and isn’t available as a lump sum.
Let’s use an example to demonstrate. If you have $100,000 in a fixed index annuity with an income benefit growing at 6%, in roughly ten years, your annuity will be worth around $200,000. You cannot take this as a lump sum – this figure is a calculation based on how much income the annuity generated. That 6% growth-rate of $200,000 equates to $12,000 a year of guaranteed income. That’s $1,000 a month guaranteed income for the rest of your life, generated by the fixed index annuity income rider alone.
Suppose you’ve calculated your essential income needs at $4,000 per month, but your Social Security will only give you $3,000. In that case, we can work out how much you should put in a fixed index annuity with an income rider to guarantee that extra $1,000.
The income rider creates, in essence, a pension that you cannot outlive. Even if your annuity account’s value decreased to zero, you would continue to receive payments through the income rider.
Why an income rider could suit your future
If you’re married, you may want the guaranteed income to last for the entirety of both yours and your partner’s lives. You can choose to have survivorship, but this will decrease your monthly income, similar to a pension.
You do not have to decide whether your annuity income rider is dual or single life until you start taking income. This is a plus point for annuity income riders as it offers flexibility for the future. If you set up an income rider today but won’t need your income for the next five or ten years, you won’t have to choose dual or single income until you’re ready to take it.
In most cases, you can start taking income from your annuity after a year. But, just like a Social Security benefit or pension, the longer you wait, the higher your income will be.
How could an income rider increase your guaranteed income?
We understand that annuities are a complex and often confusing product and visualizing how they suit your situation can be difficult. If you’d like to see how an annuity could benefit your specific retirement plan, we can help.
Our advisors can show you how an income rider could impact your guaranteed income when you book a complimentary 15-minute phone consultation. On the call, we can discuss how an annuity would work for you and how it could help you meet your essential income needs. If you want to speak to a team member, book your call today.