The Five Factors That Decide Whether an Income Rider Fits Your Plan
Before you can decide when to use an income rider, you need to understand what it is. An income rider is something that’s added to a fixed indexed annuity (FIA) that guarantees lifetime income, no matter how the underlying index performs. It usually costs between 0.95% and 1.25% of your benefit base each year.
Whether that fee earns its keep depends on five specific factors in your situation. Here’s an income rider decision framework you can use.
- Pension status. Do you already have a defined-benefit pension covering essential expenses, or are you looking for a way to create lifetime income?
- Longevity expectation. How long do you and your spouse realistically expect to live? Riders pay off the longer you live.
- Risk tolerance. How much would a bad market in the first decade of retirement disrupt your plan?
- Liquidity needs. How much of this money do you need to be able to access without penalty?
- Spouse situation. Is there a survivor who will need this income to continue after your death?
The five profiles below walk through some examples of how those factors might play out.
Profile 1: The No-Pension Pre-Retiree
Who This Is
This retirement saver is 58 years old and has $500,000 invested. He earns a salary through a corporate job and has no defined-benefit pension. He’s heard of sequence-of-returns risk, which occurs when a market downturn in the first few years of retirement puts hard-earned savings at risk.
What Risk the Rider Addresses
An income rider addresses sequence-of-returns risk by guaranteeing a fixed lifetime income amount regardless of how the market performs in the first five to ten years of retirement. A downturn while you’re taking income won’t reduce the amount you regularly receive.
Worked Example
Here’s what that looks like in practice. A 58-year-old investor puts $250,000 into a fixed index annuity today with a 7% compound rollup rate. (For illustration only; actual rollup rates vary by carrier and contract.) That means the benefit base grows by 7% each year on the prior year’s balance. The “benefit base” is a bookkeeping figure used only to calculate future income, not the cash the account owner can withdraw.
By age 68, that benefit base has grown to about $492,000. At a 5.5% withdrawal rate, that’s about $27,060 per year for life, locked in regardless of what the market does between the ages of 58 and 68.
When This Profile Should Pass
If the investor in this example is expecting a substantial inheritance, has a second career on the horizon, or already has significant cash reserves and a paid-off home, the rider’s protection is solving a problem that doesn’t actually exist.
Profile 2: The Early Retiree Bridging to Social Security
Who This Is
This 62-year-old is retiring early, but plans to delay Social Security until age 70 to maximize the benefit. That’s a smart strategy; the increase in Social Security income from 62 to 70 is about 77%. But the problem here is: There’s an eight-year income gap that has to be funded somehow.
What Risk the Rider Addresses
In this case, the income rider can help address the eight-year drawdown gap, during which a Social Security delay strategy is most vulnerable.
Worked Example
It might work like this: A buyer puts $300,000 to work at 62 (For illustration only — actual rates vary by carrier and contract. and uses the rider’s guaranteed income to bridge the 8 years until Social Security activates at 70. The rider does exactly what it’s built to do.
The problem is that a Single Premium Immediate Annuity (SPIA) does the same job and writes a bigger monthly check on the same $300,000.
The reason is straightforward. An indexed annuity with an income rider is a bundle of features. Your $300,000 is paying for the lifetime income guarantee, plus a cash value you could walk away with, plus the chance to earn more if the market does well.
Each of those features costs the insurer money to provide, and they recover that cost by paying you a smaller monthly check. A bridge buyer between 62 and 70 is spending the money down, so they’ll never use the cash value or the market upside. They’re paying for features they won’t touch.
A SPIA strips all of that out and converts more of every dollar into income.
An agent may pitch a deferred income annuity (DIA) for situations like this, but it doesn’t fit an eight-year bridge starting now. As the word “deferred” implies, a DIA is a SPIA you buy today and turn on at a future date. But for a buyer who needs the paycheck to start at 62, the SPIA is the better option.
Ask your agent for a quote on an FIA with an income rider, as well as a SPIA before signing anything. For an eight-year bridge to Social Security, the SPIA almost always wins.
When This Profile Should Pass
If your bridge between retirement and Social Security is shorter than the eight years in this example, the case against the rider gets even stronger.
With less time for the rollup to grow the benefit base, the rider has even less to offer. A SPIA, a multi-year guaranteed annuity (MYGA) held to maturity, or even a short-term Treasury bond ladder will deliver more income per dollar with fewer moving parts.
Profile 3: The Spousal-Continuation Buyer
Who This Is
Our next example is a married couple. The primary earner is 65, and is worried that his spouse will lose pension survivor benefits or face the Social Security “widow’s gap.” That’s the drop in household income when one spouse dies, and the surviving spouse keeps only the larger of the two Social Security checks instead of both.
What Risk the Rider Addresses
A joint-life rider guarantees that the same lifetime income continues in full to the survivor, with no reduction or recalculation.
Worked Example
Here’s how the joint-life version compares. (For illustration only — actual rates vary by carrier and contract.) The couple puts $400,000 into a FIA with a joint-life income rider, with both spouses named as covered lives, so the income guarantee applies to both, regardless of who dies first.
When they activate the income rider, they use a 5% joint withdrawal rate, slightly lower than the 5.5% they’d get on a single-life rider. That 0.5% is the cost of the survivor guarantee. If the primary earner dies at 78, the surviving spouse continues to receive the full income for the rest of his or her life.
That compares favorably to a half-pension widow scenario, where household income could drop by 30% to 50% at the worst possible moment.
When This Profile Should Pass
If both spouses have generously defined pensions or if the surviving spouse will inherit substantial taxable assets that can fund income organically, it doesn’t make sense to purchase this rider.
Profile 4: The Lump-Sum Pension Rollover
Who This Is
This 60-year-old just took a $400,000 lump sum from a former employer’s pension plan. She had reasons: Maybe the survivor benefit was paltry, maybe she wasn’t confident in the plan’s long-term funding or perhaps the lump-sum offer was priced more favorably.
But now she’s sitting on the cash and doesn’t want to manage it actively for the next 30 years. What she actually wants is the thing the lump sum lets her keep control of: a monthly check for life.
What Risk the Rider Addresses
This isn’t so much about market risk as about recreating the pension structure. This investor wants a guaranteed lifetime payout, not a strategy that depends on market performance and requires regular investment decisions over the next 25 years.
Worked Example
Here’s the way to view this comparison. (For illustration only — actual rates vary by carrier and contract.) She plans to roll the $400,000 into an FIA with an income rider, activating it at age 65. Before making the purchase, she should weigh the monthly income against what the original pension would have paid as a monthly check, starting at the same age.
Sometimes the rider wins, especially if the company’s lump-sum offer was stingy, relative to the monthly pension it replaced.
Sometimes the pension’s check is better, especially if it rises with inflation each year through a cost-of-living adjustment.
When This Profile Should Pass
If the original pension’s monthly check, adjusted for inflation, would have paid out more over her lifetime than the rider does, the answer is easy: Take the pension. There’s no need for the rider in that case. This is where it’s important to understand the math before buying a rider.
See How Much You Could Earn With Today’s Best Rates
Profile 5: The LTC-Worried Buyer
Who This Is
This buyer, who’s 65 or older, doesn’t qualify for standalone long-term care insurance. Either they were declined for health reasons or the quoted premiums were too high. This person has some retirement assets, but no specific plan if long-term care becomes necessary.
What Risk the Rider Addresses
Most of the time, there’s a sudden jump in expenses when someone needs skilled care. Many newer income riders include a feature, sometimes called an “LTC doubler,” that, as the name implies, doubles your guaranteed income for up to five years. It kicks in if you can’t handle a set number of basic daily tasks on your own, such as bathing, dressing, or eating.
Worked Example
Here’s how this looks. (For illustration only — actual rates vary by carrier and contract.) A buyer puts $300,000 into the contract with an LTC-doubler rider. At the time of a qualifying care event, the base income of $16,000 a year doubles to $32,000 for up to five years.
That extra $80,000 of cumulative income can help offset home care or assisted living costs without forcing the sale of other assets. That’s useful when the retiree doesn’t want to feel pressure to sell their home at an already stressful time, for example.
When This Profile Should Pass
If they already have substantial liquid assets earmarked for care, a hybrid life/LTC product is usually a better option. If they can still qualify for a traditional LTC policy, that’s almost always more efficient.
Three Scenarios Where You Should Walk Away
Not every situation calls for an income rider, and it’s smart to weigh the annuity income rider pros and cons. For example, in these situations, it would be tough to justify:
- You have a strongly defined benefit pension covering essential expenses. If your floor is already guaranteed, paying around 1% per year for another guarantee is layering protection on protection and could ultimately be a waste of money.
- Family longevity history under 75. Income riders pay off the longer you live. If both sides of the family have a history of dying in their early 70s, the rider math rarely works.
- Less than $200,000 total invested. With smaller account sizes, the rider’s annual fee eats up a good chunk of your returns. The guaranteed income may be too small in actual dollars to be worth the added complexity.
