Annuities can be complex instruments. They can come in all shapes and forms, from immediate to deferred, from fixed to variable, from single life to joint life and everything in between. However, no matter how complex and seemingly custom-tailored, no annuity is ever perfect. That said, you can make them as good as you want by adding one or more annuity riders. If you’re wondering what that means, this post discusses what annuity riders are, how they work, their pros and cons, and the most common options insurance companies will offer when crafting the perfect contract.
What are annuity riders?
An annuity rider or contract provision is an add-on to your annuity contract that can provide you with additional benefits, income or protection. Riders are available for all types of annuities, including:
- Fixed or variable immediate annuities
- Fixed or variable deferred annuities
- Indexed annuities
- Multiyear Guaranteed Annuities or MYGAs, and the rest.
The main goal of adding riders to an annuity contract is to offset some of the cons or drawbacks that some standard contracts come with. In other words, they’re an option offered to make the contract more attractive from the purchaser’s point of view.
For example, annuitizing a deferred annuity usually means that the insurance company will pay you an agreed amount of income for the rest of your life. The insurance company will calculate how much to pay you by estimating how long you’ll live and ensuring that your contract will last up to that exact date. However, if you die sooner than expected, the insurance company will keep the remaining value of your contract to offset the cost of paying those who outlive their life expectancy. If you don’t want to lose your money and leave it to your heir, you’ll need to add a special provision or income rider.
How do annuity riders work?
You can usually add a rider to an annuity contract either at the time of purchase or later on down the road. This allows you to personalize your contract to fit your evolving needs.
The main purpose of annuity riders is to change some aspect of your contract, whether that means increasing income payments, providing a death benefit for your beneficiaries or ensuring that you won’t lose money in the case of an early withdrawal. In other words, riders are contract provisions that come into effect only if certain conditions are met. There are many different types of annuities, and there are also different annuity riders, so the conditions that trigger a contract rider vary.
As pointed out in the example above, some riders come into effect if the policyholder dies earlier than expected and there is still money in the contract. Others will only pay out if and when you need money to pay for long-term care or under certain disabling health conditions.
In addition, the specific riders offered will vary from insurer to insurer, making it essential to read the fine print and get adequate counselling when choosing the right rider for one of these complex investment instruments for retirement.
Pros and cons of annuity riders
There are both pros and cons to adding riders to your annuity contract.
Annuity rider pros
On the plus side, riders can provide you with additional benefits and protection that you might not have had otherwise.
For example, as we saw in the previous section, some riders will kick in if you die earlier than expected and there is still money left in your annuity contract. This means that your beneficiaries will get paid out rather than the insurance company keeping the remaining funds.
Some riders let you enter the stock market under controlled conditions, limiting your exposure and setting a floor that protects your principal while letting you take advantage of a higher rate of return. In short, the main pro behind annuity riders is that they let you personalize your contract to fit your particular situation, expectations, and risk tolerance.
Annuity rider cons
On the other hand, adding riders to an annuity contract has downsides. First, it makes an already complex investment contract even more complex and harder to understand. Many retirees or people investing for retirement find it hard to navigate the legal jargon and the numbers to get a good idea of how much they can expect to receive and under which specific conditions.
But complexity is not the only problem. Riders help you reduce risk – the risk that you’ll outlive your savings; the risk that you’ll die early and lose money your beneficiaries could otherwise inherit; the risk that your income will lose value to inflation over time, etc. But taking that risk off your shoulders doesn’t make it go away; it simply passes on to someone else, in this case, the insurance company. To offset this increased liability, the insurance company will charge fees which makes adding riders expensive.
These fees may not seem like much at first, but when you factor in compounding interests you didn’t gain because of these fees, they can cost you thousands of dollars in retirement.
Types of annuity riders
There are many different annuity riders, each with specific conditions and purposes. However, we can classify them into two major categories, depending on who they actually benefit, either the contract owner or their heirs. In this sense, there are two distinct types of annuity riders:
- Life benefits
- Death benefits
As the name implies, life benefit riders provide additional benefits to the annuity contract owner while they are still alive and kickin’. The most common type of rider in this category is the income rider, which we’ll talk about in a minute, but there are several others in this category.
These riders are designed to protect your beneficiaries if you die while your annuity contract is still active. In other words, death riders ensure that you’ll be able to leave something behind once you pass away, provided there is still value in the contract (i.e., provided you haven’t withdrawn all of your principal). Death benefit riders can also come in different forms, some of which even help offset potential income tax so that beneficiaries can make full use of what they inherit.
The nine most common annuity riders explained
In the following section, we’ll talk about some of the most common riders the biggest insurance companies offer. The particular names of each product vary from one insurance company to the next, but the features or benefits are usually common in all cases.
#1 Income riders
Annuity income riders are a type of living benefit rider that provides guaranteed income payments for the life of the annuity contract owner. You can use these payments to cover expenses, supplement retirement income, or anything else you might need regular cash flow for, ensuring you won’t be able to outlive your savings.
There are two main types of income annuity riders:
- The guaranteed income rider: this rider is added to an annuity contract at the time of purchase and provides guaranteed income payments for a specified period, usually for as long as you live. The great thing about this rider is that it ensures you won’t have to worry about market volatility or other factors affecting the value of your annuity contract, as your income payments are locked in.
- Guaranteed minimum living benefit: this type of rider is usually added to either variable annuities or indexed annuities that offer income payments that can go up or down based on the performance of the underlying investment or index. The rider is meant to protect you from downside risk by guaranteeing that your payments will never go below a certain level, regardless of how poorly the markets perform.
#2 Cost of living riders, a.k.a. inflation benefit riders
A cost of living rider helps offset the effects of inflation on your income payments. By adding one to your annuity contract, you can ensure that your income payments will increase over time at a rate equal to or greater than the inflation rate. This way, you can keep up with the rising costs of living and maintain your purchasing power well into retirement.
#3 Guaranteed minimum accumulation benefit
The guaranteed minimum accumulation benefit (GMAB) rider is usually added to deferred variable and indexed annuities, and their goal is to protect your principal from market fluctuations by ensuring a minimum interest rate throughout the accumulation phase.
This guaranteed growth is lower than what insurance companies offer in the case of fixed-rate annuities, but that’s only a floor rate. You’ll usually earn a higher percentage, thanks to market performance.
#4 Death benefits
As we mentioned before, death benefit riders are designed to protect your beneficiaries in case you die while your annuity contract is still active. In most cases, the beneficiary will simply receive the value of the annuity contract at the time of your death as a lump sum. However, some riders let them spread payments across five years (as per the five-year rule) or longer (if they decide to annuitize the inheritance) or even exchange the annuity contract for another one in their name.
#5 Enhanced death benefit riders
This rider is usually added to immediate annuities. Like a normal death benefit, it’s meant to provide protection for your beneficiaries if you die soon after beginning to receive income payments from the annuity contract.
The “enhanced” part of the rider comes in the form of a bonus designed to provide a larger death benefit than what the underlying annuity contract would normally offer. The intention is usually to offset taxes on the contract’s entire value (in the case of qualified annuities) or its earnings (in the contract was paid for with post-tax dollars, i.e., non-qualifies annuities) so that your beneficiaries can enjoy more of what you leave behind. Depending on the insurance company and rider terms, bonuses can sometimes be as high as 30% of the contract’s value at the time of your death.
#6 Commuted payout rider
Also known as a guaranteed withdrawal benefit rider, this rider is usually added to deferred income annuities, and it allows you to withdraw a preset percentage of your contract’s value before it’s set to mature without paying surrender fees. In other words, these riders are put in place to give you access to your money in case you need it, but keep in mind that you may have to pay the IRS a 10% early withdrawal fee if you withdraw before turning age 59½.
#7 Long-term care riders
A long-term care rider is an add-on you can add to either immediate or deferred annuities, and its purpose is to provide additional income payments to help cover the costs of long-term care if you need it. In other words, when they kick in, they increase your contract’s value, in some cases doubling it. Take note, though, that some of these riders include provisions that only allow you to use the extra income for the intended purpose (long-term care), so you don’t have free access you the extra cash.
#8 Disability income rider
This rider aims to provide additional income payments if you become disabled and cannot work. These riders usually have a “look-back” provision, which means that the insurance company will review your medical records for a certain period (usually up to 5 years) before the rider was added to see if you had any pre-existing conditions that would have made you ineligible for the rider.
#9 Impaired risk rider
An impaired risk rider is meant to provide protection for those already facing health issues when they purchase an annuity contract, accelerating their payout. In other words, the rider ensures a higher payout due to the probability of an earlier death and the need for higher income due to health conditions.
The bottom line
Annuity riders can be a great way to get extra benefits and protections for your annuity contract. They can provide death benefits, income protection in case of disability or long-term care costs, and other perks. However, it’s important to read the fine print and understand what each rider entails before you sign up, as some have limitations on how you can use the extra income they provide. Understanding how each rider works and what it’s for, and how much it will cost is the best way to make a financially sane decision as you plan for retirement.