How Variable Annuity Living Benefits and Death Benefits Work

Annuity riders can be expensive so avoid features you don't need

Senior woman using laptop to check on her variable annuity.
Living benefit riders can be great in a down market. Nick Clements/ Taxi/ Getty Images

A basic variable annuity offers tax-deferred growth and a selection of investments. It guarantees your original contribution amounts as a death benefit. But most variable annuities are not basic. Extra features such as enhanced living benefits and enhanced death benefits are becoming more and more common. Here's how these features work.

Living Benefits

A living benefits rider offers some type of guarantee as to the amount of income you can withdraw while you're alive.

This rider is intended to provide you with a safety net. It's a way of insuring that your retirement income will still be there when you need it.

But as with any form of insurance, this benefit comes with a price—typically in the range of .25 percent to 1 percent a year. Other fees and expenses inside the annuity may apply as well. 

The annuity policy might require that you annuitize your policy, which means that you would turn it into an immediate annuity to be able to exercise these features. Or you might be required to own the policy for a minimum number of years, such as 10, before the rider can be used.

The Income Base 

Many policies guarantee that something called your "benefit base" or "income base" will grow at a fixed rate of return. You can then withdraw 4 or 5 percent of that income base at a specified age, and that withdrawal amount is guaranteed for life even if the investments don't perform well.

Annuity buyers commonly mistake this income base for their account value, but the income base is actually an accounting entry—it's sort of a phantom account. It's only used to calculate your allowable withdrawal amount.

Your actual account value is what you get if you cash in the policy. If the investments do well, your actual account value is likely to be higher than your income base.

If the investments have not done well, your actual account value will likely be less than the income base. The guaranteed income from the income base can prove to be a valuable feature in a prolonged period of poor market returns because it guarantees a portion of your retirement income. 

Understand the Rules 

Living benefits can provide guaranteed retirement income, but you must make sure that you understand what requirements you must meet before you can use the guarantees. Ask these questions about your variable annuity before you opt in for a rider. 

  • How long do you have to own the policy?
  • What is the cost?
  • Can the rider be terminated and the cost terminated if you no longer need it?
  • Are you required to annuitize the contract to use the benefit?

Don't buy a policy with a living benefit unless and until you understand how the benefit works and when you can use it.

Enhanced Death Benefits

The basic death benefit offered by a variable annuity is a guarantee that after your death, the insurance company will pay your beneficiary at least the amount you put in. But that doesn't sound like much of a benefit, and that's why many annuities offer some form of an "enhanced" death benefit as well. 

An enhanced death benefit comes in the form of a death benefit rider that offers monthly or annual “step-ups." If the policy has a monthly step-up, the insurance company takes a snapshot of your account value each month. The highest monthly recorded value becomes the death benefit amount when you die, even if the market value is currently less. Most death benefits are reduced for any withdrawals you take.

These death benefit riders cost more than the basic death benefit itself. A death benefit rider that has a monthly step-up might cost you anywhere from .25 to .50 percent of the account value per year. A cost of .50 percent a year can add up considerably over time. 

Death benefit riders that offer monthly or annual step-ups can provide a way for you to lock in market gains to pass along to your heirs.

If you can't qualify for life insurance and you don't need to use the funds yourself during your lifetime, this can be a great way to provide an extra benefit to beneficiaries. The gain might not be passed along as tax efficiently as other alternatives, however. 

A Word of Warning 

If you have too many extra riders on your variable annuity, the fees can add up to 3.5 percent to 4 percent a year. High fees make it almost impossible for the investments to perform well enough to earn back the fees and grow, so be cautious about adding features that you don't really need.