Annuity income riders are optional features that can protect the money in an indexed or variable annuity from losses or lukewarm market performance. They guarantee the policyholder or annuitant a minimum amount of money via a stream of lifetime income or withdrawals, depending on the type of rider selected. Funds are guaranteed regardless of how long the policyholder or annuitant lives and how well (or poorly) the underlying indexes or mutual fund(s) in the annuity perform. Plus, one type of annuity income rider does not require you to annuitize.
Annuity income riders are more complicated than you might think. So before you add one to your annuity contract, learn how they work and whether they are worth the additional cost.
Definition and Examples of an Annuity Income Rider
Annuity income riders are one way to protect against market losses (or in the case of an indexed annuity, lukewarm market performance). Even if your annuity loses money, you’re still guaranteed a minimum income or withdrawal amount.
When you buy an indexed or variable annuity, the money in that annuity grows according to how the market performs. In an indexed annuity, you’re protected from market losses but only get a portion of market gains credited to your account. In a variable annuity, you’re 100% exposed to market gains and losses, and could potentially lose all the money in your contract.
Indexed and variable annuities are deferred annuities and are designed to accumulate value for a number of years before you take income from them during retirement. The larger the contract value at that time, the larger the amount of income or withdrawals you’ll have access to. The reverse is also true.
Annuity income riders can help protect against losses so that you’re guaranteed to receive money even if the contract value goes to zero.
Types of Annuity Income Riders
There are two general types of annuity income riders: guaranteed minimum withdrawal benefit (GMWB) and guaranteed minimum income benefit (GMIB). Each makes use of a second, pseudo, account value in order to determine the income guarantee. To better understand each type of rider, it’s helpful to take a closer look at the “two” account values.
When you purchase an annuity with an income rider, the life insurance company that issued the annuity contract essentially creates two accounts for you.
The first is the cash account, which reflects the actual cash value of the annuity. This means that it is funded with real money and will rise and fall in value based on the performance of the underlying funds in which the money is invested, or the stock market indexes to which performance is tied.
The second account that is created is often referred to as the income or benefit base. This account is hypothetical, meaning that it is not funded with real money. It starts with the same purchase value as the actual contract and then grows at a guaranteed rate (such as 5%) each year and/or ratchets up to the highest anniversary contract value.
For example, even if your annuity only averages annual growth of 3.5%, when you’re ready to start drawing income, you would get a payout that is based on the hypothetical income account value that grew at 5% per year.
The “benefit base” and “income base” are pseudo contract values that are used only to determine the amount of the allowed withdrawal or income. They are not actual contract values that can be accessed in a lump sum by the policyholder. Different insurers may use a variety of names for these accounts.
Guaranteed Minimum Withdrawal Benefit (GMWB)
This type of rider guarantees that you can withdraw a certain percentage of funds based on a “benefit base.” This amount may be determined by the highest contract value reached on any contract anniversary or by a set percentage credited annually to the benefit base. You can activate the GMWB rider without annuitizing the contract.
Guaranteed Minimum Income Benefit (GMIB)
This type of rider provides a guaranteed minimum level of income based on an “income base,” which may also go by other names. This value may be determined by the highest anniversary value your contract reaches before you exercise the benefit or by an annual accumulation rate credited to the value of the income base.
A GMIB requires that you annuitize the contract to receive the benefit, which means that you give up access to the actual contract value in exchange for a guaranteed stream of income.
Annuity income riders can go by several different names, depending on the insurance company and the specific product.
- Alternate names: Guaranteed lifetime withdrawal benefit, lifetime income benefit, living benefit
- Acronyms: GMWB, GMIB, GLWB, LIBR
How Does an Annuity Income Rider Work?
GMWB and GMIB riders have key differences that can make them more—or less—appealing, depending on your situation and income goals. Both types typically promise that you’ll receive at least a certain guaranteed payout from the annuity each year, even if the markets go to (and stay at) zero for the foreseeable future.
With a GMWB, you’re guaranteed a certain percentage of a benefit base every year in the form of lifetime withdrawals. You’re not required to annuitize the contract to activate the benefit, so you can withdraw the entire account value if you choose, or withdraw more than the guaranteed lifetime withdrawal amount. However, doing so will impact and could void the guarantee.
With a GMIB, you’re guaranteed a lifetime stream of income that’s determined by the value of the income base, as well as your age and gender at annuitization (and the age and gender of any joint payee). To activate a GMIB, you are required to annuitize the contract, which means giving up access to the contract value.
A GMIB rider requires annuitization. A GMWB rider does not. Since both types of riders are called by very similar names, be sure to ask if the one you’re considering requires annuitization or if you can still access the underlying contract value once the benefit is activated.
Suppose you invest $200,000 in an annuity with a GMWB that guarantees your benefit base will increase by at least 5% every year. Even if your investments underperform that benchmark, you can still have a lifetime stream of withdrawals determined by the value of the benefit base.
In other words, if your contract value is still at $200,000 in 10 years when you want to retire, the amount of income you can receive will be calculated based on about $325,779 (5% compounded annually on $200,000) instead of $200,000. You aren’t required to annuitize to access this benefit, either.
Now, suppose that your annuity has an annual “ratchet up” feature that bumps up your benefit base to the highest value on any contract anniversary. Let’s suppose your highest anniversary value, and so the value of the benefit base, is $400,000. If your current contract value is lower, say at $350,000, when you want to begin withdrawals, your guaranteed withdrawal amount would be calculated based on $400,000.
An annuity with a GMIB rider may have an income base that is similarly determined. However, you’d need to annuitize the contract and give up access to the actual contract value in order to activate the guaranteed income stream. Depending on your age at annuitization and other factors, it’s possible that income payments with a GMIB would be higher than the withdrawal amounts you’d have access to via a GMWB.
In either case, if the contract performed well and is worth more than the benefit or income base when you’re ready to retire, you could:
- Take withdrawals based on that amount
- Annuitize the contract based on that amount
- Withdraw the entire lump sum or any other amount you wish
Even though you aren’t required to activate the benefit, you can still elect to annuitize an annuity with a GMWB rider.
Annuity Income Rider Costs
The security provided by this rider comes at a price. The life insurance company will deduct a fee from the actual cash value account each year. It may be up to 1% or more, depending on the features of the rider. This charge effectively lowers the overall rate of return earned in the cash value of the contract.
Withdrawals made before and after (in the case of a GMWB) you exercise the rider may decrease the value of the benefit base, and thereby the amount of income you receive from it. Before adding an income or withdrawal benefit rider, make sure you understand how your contract will treat withdrawals and if there is a maximum amount you may withdraw without decreasing the benefit base.
Annuity income riders can vary in many respects from one company and product to another. Some come with additional features such as a cost of living adjustment (COLA) or an increased payout in the event of disability or the need for some form of managed care.
How Do I Get an Annuity Income Rider?
While you can work with your financial advisor or insurance company to add an income rider to your annuity contract, make sure to ask the following questions:
How Do Available Riders Work?
Lifetime income riders may be referred to by several different names that often sound very similar. For example, a guaranteed minimum withdrawal benefit is not the same as a lifetime income rider, but could be referred to as a lifetime income benefit rider. Ask if any riders you’re considering require annuitization—that’s the telltale difference. And if you’re considering a GMIB (which requires annuitization), make sure the benefits outweigh the requirement that you forgo your contract value in order to use it.
To compare riders, ask the life insurance agent or your financial advisor to run hypothetical scenarios to help you understand how each rider might play out over time.
How Will the Rider’s Cost Impact Returns?
Make sure to find out how much each rider will cost on an annual basis, and ask your agent to run hypotheticals to illustrate how costs might impact performance over time. Compare the impacts of those costs on contract values between riders as well as to a contract without them.
Is the Insurance Company A-Rated?
Make sure the life insurance company is financially solid by reviewing its ratings with agencies such as A.M. Best, Fitch, Moody’s, and Standard & Poor’s. The income benefit it promises is only as good as the company’s financial ratings, so look for companies rated at least an A or higher in order to be safe.
- Many indexed and variable annuities offer at least one type of annuity income rider.
- Some annuity income riders require that you annuitize your contract—give up access to the lump sum—to use the benefit.
- The guaranteed income or withdrawal amounts are based on a second hypothetical account value that may grow annually at a set percentage or that may lock in account gains, even if the underlying contract loses value.
- The payouts from annuity income riders are designed to last a lifetime.
- There are several different types of annuity income riders—as well as many different names for them—so do your homework before choosing a financially sound annuity with the rider option you need.