Do you need an extra layer of protection in an annuity?

Fixed indexed annuities offer built in protection, but is that enough?

Fixed indexed annuities have boomed because they offer a chance to get a good portion of the stock market’s gains while offering complete protection from loss. They credit interest based on the growth of a market index, such as the Dow Jones Industrial Average or S&P 500. But you lose nothing in down years.

You can increase the comfort factor by buying additional protection with a lifetime income guarantee rider. Since an indexed annuity is already protecting you from loss, is adding another layer a good idea?

It all depends on your needs, goals and plans.

Protection from potential loss

It doesn't make sense to buy additional protection unless it meets your strategy. Most important, you should feel sure that you’ll use the feature eventually. Otherwise, you're wasting money on something you may not use.

But if you do plan to use it and have a good strategy, the income rider can be a wise purchase.

A lifetime income rider is designed to help generate more guaranteed lifetime income at a future date, while still giving you complete control over the money in your annuity. Since you don’t set the date for income payments to start when you buy the annuity, you retain planning flexibility in the future.

Some marketers call the arrangement a hybrid annuity, but I’m personally not fond of that terminology.

Normally, when you convert an annuity into an income stream through annuitization, its cash surrender value becomes zero. That’s not the case here. You still own the full value of your annuity. The rider guarantees the amount of lifetime income that your deposit will generate in the future.

Most insurers charge an annual fee for this option, usually around 1% of the assets in the annuity. You can choose any time to start receiving lifetime income.

The guaranteed payment amount you will receive for the rest of your life is determined by the income account value and your gender and age at the time you start receiving payments. Prior to activating lifetime income, the income account value typically grows at a guaranteed annual compounded rate of 4 to 8 percent.

What’s a bit confusing is that the income account value and value of your contract are separate. The income account value is used only to calculate the amount of your guaranteed income payments.

It is not the same thing as your underlying contract value. It has no cash value and cannot be withdrawn. The contract value has cash value and can be withdrawn.

How it works

Take this situation for example; Jane buys an indexed annuity at age 55, deposits $100,000 in it and chooses an income rider. It’s up to her when to start receiving payments.

Ten years later, she decides to start receiving income. In the interim, the income account value has grown at 7.5 percent compounded annually. Starting at age 65, she gets $11,352 a year for the rest of her life.

Meanwhile, supposed she has earned an average of 5% a year (after rider fees) on the separate annuity contract value. The annuity itself is now worth $162,889. Jane is free to let that money continue to accumulate or withdraw part or all of it.

There’s no free lunch. Because of the one percent annual fees, the annuity cash value is significantly less than it would have been without the rider. However, this disadvantage may be more than offset by the guaranteed income.

After income activation, annual payments are deducted from the contract value. If that value ever reaches zero, annual income payments are still guaranteed for the remainder of your lifetime, but the annuity would no longer have any cash surrender value.

If you die before income activation, your beneficiaries will receive the full annuity contract value as a death benefit. If you die after income activation, the income payments will cease and your beneficiaries will receive any remaining annuity contract value. Lifetime income riders vary dramatically from one annuity company to the next. Shop around and compare.

An income rider is one way among several to guarantee your future income, but another way is to just buy a deferred income annuity.

For more personal finance insights, read on here!

Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. It provides a free quote comparison service. launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities.

AnnuityAdvantage’s Income Rider Calculator page provides an instant estimate of the future income you could expect from a lump sum premium deposit. https://www.annuityadvantage.com/resources/financial-calculators/income-rider-calculator

More information, including updated interest rates from dozens of insurers, is available at https://www.annuityadvantage.com or (800) 239-0356.