Living Benefit Riders

What Is a Living Benefit Rider?

Beyond the fixed and variable structure, annuities can be customized to include a range of other features that allow you to achieve a better outcome. These features are commonly referred to as riders, and they come in the form of death benefit riders and living benefit riders.

Living benefit riders guarantee some sort of defined payout while the annuitant is alive. Generally, they offer upside exposure and/or downside protection to market forces — in turn, boosting the value and longevity of your annuity.

Death benefit riders, on the other hand, protect an annuitant’s beneficiaries against a drop in account value due to market conditions. In the event of the annuitant’s death, they guarantee a specified payout to the beneficiaries. The payout can vary, with more generous payouts coming at a higher cost.

Living benefit riders offer increased flexibility to an annuity. Contact your financial professional to see if the cost of adding a living benefit rider will be worthwhile for your situation.

— Timothy Li, MBA

How Do Living Benefit Riders Work?

Living benefit riders can be added to both fixed and variable annuities, but they are mainly associated with variable annuities. These riders come in many shapes and sizes, but they can generally be categorized into three types of features.

Living Benefit Rider Features

Guaranteed lifetime withdrawal benefit

A rider that allows you to make lifetime withdrawals from an annuity if the annual withdrawals are within specific parameters. Essentially, this guarantees a minimum long-term rate of return while providing near-term liquidity.

Guaranteed minimum accumulation benefit

A rider that ensures you retain the value of your purchase payments, regardless of investment performance.

Guaranteed minimum income benefit

A rider that guarantees a minimum future income level, regardless of how the market performs. In order to trigger the benefit, the contract must be annuitized, which means exchanging its value for a guaranteed stream of income.

It’s important to note that the name and details of these benefits vary across financial institutions, so confirm you are getting the correct one.

Guaranteed Lifetime Withdrawal Benefit

Assume you purchase a $100,000 variable annuity with a guaranteed lifetime withdrawal benefit. The terms of the rider allow you to withdraw a certain percentage of your investment each year for life, regardless of how the market does and if your account fluctuates. The acceptable amount usually ranges between 3% and 6% and increases if you wait to begin taking withdrawals. Once triggered, the annual percentage is generally frozen.

Guaranteed Minimum Accumulation Benefit

Assume you purchase a $250,000 variable annuity contract with a guaranteed minimum accumulation benefit rider. Then, your investment selections perform poorly over the accumulation period, and the value of your account declines to $175,000. If you were to liquidate the account, you’d be able to recoup your initial $250,000 investment because of the guaranteed minimum accumulation benefit rider.

Alternatively, if you were to retain the annuity and trigger your promised stream of income payments, they will be based on the $250,000 rider value, not the lesser account value of $175,000.

Guaranteed Minimum Income Benefit

Assume you invest $100,000 in a variable annuity at age 40. The money is allocated across various investments, and you opt to complement your choices with a guaranteed minimum income benefit rider that promises a growth rate of 6% per year.

Twenty years later, at age 60, the actual contract value is $250,000, which reflects an annualized rate of return of 4.69%. If you opt to annuitize the contract and commit to a guaranteed stream of income, then the enhanced living benefit rider will pay you a stream of income that is based upon a value of approximately $321,000, not $250,000. The higher amount reflects your initial $100,000 investment compounded at 6% annually for 20 years.

How Much Do Living Benefit Riders Cost?

A living benefit rider can increase the value of your annuity and its longevity. However, these add-on features are not free. They come at a cost that reduces the value of your annuity contract each year.

For example, the rider in the guaranteed minimum accumulation benefit scenario above could charge an annual fee of 1%. This fee is charged regardless of the performance of the contract.

So, in the first year, the fee would be $2,500 ($250,000 × 0.01 = $2,500). The charge will rise or fall with the value of the contract, but it will always be collected.

However, because of the rider, you can count on the return of your principal, regardless of the performance of your investments. Unfortunately, if your investments do very well, your total return may be diminished by the fee of the rider.

Weighing the Costs and Benefits

Living benefit riders can make sense when you are highly uncertain about the long-term performance of your investments. In this situation, the riders’ guarantees can justify their cost by protecting your principal and/or locking in a certain level of return.

However, if you have access to solid investment vehicles that show a clear track record of long-term growth, regardless of the near-term volatility, then the costs associated with riders are typically not worth it. This is especially true if your investing horizon is relatively long. In this case, riders will only reduce the value of your annuity.

If you’re shopping for a fixed or variable annuity, be sure to do plenty of research and make sure these products are well-suited for your retirement plan. It’s critical you understand how they work with and without the myriad of riders they offer. A fiduciary financial advisor can be an excellent resource to help guide you.