An annuity is a special type of account that will pay you a series of scheduled payments until your death. Insurance companies sell these products to people who want to make sure that they will have a source of income after they retire. There are many forms of annuities, but they all fall into two main types: fixed and variable. A fixed annuity will pay the same amount at each term, while payments from a variable annuity may differ each term, as they are based on the investments in the account.
If you're thinking about buying a variable annuity, you have many choices. A basic variable annuity offers tax-deferred growth and a wide selection of investments. It also comes with a promise that you'll receive the amount you first paid into the account in the form of a death benefit. But most variable annuities are not basic: extra options such as enhanced living and death benefit riders are becoming more and more common.
Here you'll learn about the many features of variable annuities, the rules you must follow to receive payouts, and how the death benefit rider works.
- Payments from a variable annuity are based on the performance of the investments the money is placed in.
- Your income base is the amount you can withdraw from your account at the age specified in your contract.
- Your beneficiary will receive a basic death benefit of at least the amount you put into the account unless you purchase an enhanced death benefit rider.
Living benefits are payments made during your lifetime. You can add a living benefits rider to your annuity to guarantee that you'll be able to withdraw a certain amount of income while you're alive. This will provide you with a safety net, and it's a way of ensuring that your retirement income will still be there when you need it.
A rider can perform several different functions, but it is really just a custom perk or add-on to your standard annuity contract or a way to enhance the policy for an extra cost.
As with any form of insurance, this benefit comes with a price. Living benefits riders fall in the range of 0.25-1% per year. Other fees may apply as well.
If you'd like to add these features, you might need to own the policy for a minimum number of years before the rider can be used. Or, you may have to annuitize it or turn it into an immediate annuity. This is when you convert the current cash value of the account into a payout plan rather than using it to invest. Depending on the account, you may have to pay a lump sum upfront, but you can often start receiving payouts right away.
The Income Base
Many policies guarantee that your "benefit base" or "income base" will grow at a fixed rate of return. You can then withdraw a percent of that income base once you reach a certain age, as stated in your contract. After that, the amount you can withdraw is guaranteed for life, even if the investments don't perform well.
It is common to mistake the income base for their account value. In fact, the income base is an entry used for accounting, and it works almost like a phantom account. It only is used to calculate the amount you are allowed to withdraw.
The actual account value of your account is how much money you get if you cash in the policy. If the investments in the account do well, your actual account value will often be higher than your income base. If the investments have not done well, your actual account value will be lower than the income base.
The guaranteed income from the income base can prove to be a worthy feature in times when the market may be doing poorly because it ensures that you'll receive a set portion of your retirement income despite low (or zero) market returns.
Learning the Rules
Living benefits can provide a promise of retirement income, but only if you meet certain requirements. It is crucial that you understand the rules and limits before you can count on the guarantees. Before you opt-in for a rider, read the details of your variable annuity fully, or speak with your agent and ask these questions:
- How long do you have to own the policy?
- What is the cost?
- Can the rider be terminated if you no longer need it? If so, is there a charge to end a rider?
- Are you required to annuitize the contract to use the benefit?
Don't buy a policy with a living benefit unless and until you know how it works and when you can use it.
Enhanced Death Benefits
The basic death benefit that comes with a variable annuity is a promise that the insurance company will pay your beneficiary at least the amount you put in after your death. If that doesn't sound like much of a bonus, you're not alone. "Benefit" is a term of art in this case. That's why many annuities offer some form of an "enhanced" death benefit as well.
How Is the Benefit Calculated?
An enhanced death benefit comes in the form of a rider that offers “step-ups" on a monthly or yearly basis. If the policy has a monthly step-up, the insurance company first takes a snapshot of your account value each month (or year, as per your contract). The highest monthly value on record becomes the death benefit amount when you die. It uses this figure even if the market value at the time is much less. This means that if your account performs very well for one month, it will pay off again for your beneficiaries.
Most death benefits are reduced if you have to take any withdrawals from your account.
How Much Does a Death Benefit Rider Cost?
These death benefit riders cost more than the basic death benefit itself. For example, a rider that has a monthly step-up can cost around 0.20-0.5% of the account value per year. A cost of 0.5% percent a year can add up quite a lot over time.
Who Should Buy a Death Benefit Rider?
Death benefit riders that offer step-ups can allow you to lock in market gains that you can pass along to your heirs. If you don't qualify for life insurance and don't need to use the funds during your lifetime, this can be a great way to leave extra money to your children or other beneficiaries. Taxes will apply, so before you decide on the rider, make sure you are aware of other estate planning options.
If you have too many extra riders, the fees can add up to 3.5-4% a year. High fees can make it tricky for the account to perform well enough to earn back the fees and grow. Take caution not to add features that you don't really need.