198- Catch a Ride(r) to Lifetime Income
Written by: Cary Carney, Vice President of Sales at Kuvare, Guaranty Income Life Insurance Company, a Kuvare company.
In my last post, I wrote about the downside of generalizing when comparing annuities to ice cream. I said looking at one annuity option and deciding the entire group is bad is like tasting a flavor of ice cream, not liking it, and then concluding all ice cream is bad, which I think most would disagree with.
Now, I’ll focus on a significant advantage that annuities can offer that many other financial vehicles fall short on or can’t provide—a guaranteed income. Annuities can deliver tax advantages for growth and an income stream you and your spouse can’t outlive.
That’s right! The insurance company guarantees a monthly or annual payout for life, regardless if you run out of money because you’ve outlived your funds. There are several ways to accomplish this with an annuity—purchasing an immediate annuity or a deferred income annuity, annuitizing a deferred annuity or by adding an income rider to a deferred annuity.
Let’s look at the income rider attached to a deferred annuity. The rider guarantees a monthly or annual lifetime income at some time in the future. I like this option because it typically provides more control of your funds and may allow you to stop and start income as needed. Normally there is a cost that’s paid from your account annually, typically no more than 1.50%.
There are a couple of ways to generate your income opportunities, either through a guaranteed “roll up” or simply from the annuity’s accumulated value. A roll-up option is nice because you know exactly what you will receive in the future; however, this can cost more.
Let’s say you place $100,000 into Annuity A with a guaranteed roll up of 7%. After five years your income value would be roughly $140,255. The value at which the annuity is accumulating may only be $127,628 (assuming 5% compounded annually). The accumulated value is what you could walk away with if you don’t use the income rider. The income value is only used to calculate lifetime income payouts.
There is also a payout factor used to calculate the income stream. A typical payout factor for a 65-year-old may be as high as 5%. Let’s multiply that by the income value of $140,255, providing an annual guaranteed income of $7,012 each year you live. We can add your spouse, although the payout factor is typically reduced to 4.5%. Instead of $7,012 annually for one life, it might pay $6,311 annually until the end of both lives.
Don’t shy away because it’s a little complicated. These are great options for ensuring additional income guaranteed for life that other financial instruments cannot provide.
What if it was less complex? There are products that simplify this. They use only one value—the account value. This is the amount you can walk away with, or the value from which your income is calculated. For example, let’s say you placed $100,000 into Annuity B, earning 3%. After five years the $115,927 accumulated value is a far cry from the $140,255 income value guaranteed on the other product, right?
Now it gets interesting. With Annuity B the payout factor is 6.5%. When multiplied by the account value of $115, 927, you’d receive $7,535 annually for life!
Even better yet, some products don’t reduce payout factors for joint life payouts, which can make the lifetime income significantly more competitive. For a couple, both age 65, the joint life payout would be $7,535 using accumulation values and higher payout factors versus $6,311 using guaranteed roll ups and reduced payout factors.
Why the big difference? With the accumulation style versus the roll up you may take a little more risk. It’s not aggressive to assume earning an average of 3% annually in a fixed index annuity. Keep in mind, I assumed 3%, compared to 7% guaranteed with the other product. What would it look like if the product performed at better than 3% or even close to 7%? Sometimes it pays to take calculated risks!