My Agent Guaranteed Me a 7% Rate of Return
Let me start by saying Eee Gads...!
In 2009 the Insurance Industry began to actively market
the concept of "income rider attachments" to equity indexed annuity contracts. These attachments to contracts, paid for
on annual basis by the annuity holder, would guarantee to the
policy owner a lifetime income payment at a time and point of
the owners choosing.
Income Riders have proven a boon to the Insurance Industry over the last 5 years. After all, the public is genuinely concerned about increased longevity, stock market uncertainty and the general health of social security and pension programs. Income Riders provide comforting guarantees that the annuity can augment lifetime retirement salaries.
Equity Indexed Annuities that have income riders attached send you a statement each year, or each quarter, (depending upon the insurance company). On this statement there are 2 values shown:
Keep in mind the difference in meaning behind these 2 values!
One is real money the other is not.
Your Accumulation Value will grow like this: Your Income Account Value will grow like this:
Every Year, the annual rider fee of, for example, (say 1%),
comes out of the Accumulation Value. This fee is the price you
pay for the guarantees of lifetime income from your annuity at some
point in a time of your choosing.
The lifetime income, should you start taking it, comes out of the
Accumulation Value. Often the lifetime income is higher than what
you are actually earning on your money, so you could, for example,
be taking out a 5%, 6%, 7% or even 8% payout of your original
principal each year from your own money. Obviously your principal
will deplete over time if your earnings cannot keep up. However, if
your savings run right out and you are empty, the insurer will
continually pay you that lifetime income as promised.
This, of course, is the sizzle, and the reason behind purchasing
an income rider on an annuity.
The calculation for how much money you can get for a guaranteed
lifetime income is based on a payout factor that the insurance
company has in writing.
IN the torquoise rectangle below is an example of a current popular insurer's payout factor (lifetime withdrawal rate) for one of their annuities:
so you can see in the far right hand column above exactly what the insurer would guarantee you for a lifetime payment if you started in that particular year. All you do is multiply the payout factor by the value in the Income Benefit Base (or Income Account Value). This is a lifetime payment, regardless of how long you live, and it is the virtue of income rider on an equity indexed annuity.
However, you can see that the agent that is offering the annuity to you can speak of several different "rates of return" in this discussion.
1) The "rate of growth" in the Benefit Base / Income Account Value showing the annual guaranteed growth rate.
2) The "withdrawal rate" in the ledger from the insurer which is based on your age, or joint age with spouse.
3) The "payout Rate", which is simply dividing your lifetime income amount by the original principal (yielding a fairly attractive percentage anywhere from 5% to 9%)
Now.... Here's the problem.
You thought you were getting a guaranteed 7% rate of return on your money.
Are you really ?
The real rate of return on your annuity is reflected in the accumulation value, not the income value. (The accumulation value is not shown in the chart above.)
As discussed, the income value is ficititious and not a real lump sum of money, ever.
However, when your agent told you that you would get a 7% rate of return, was he referencing the :
1) The rate of growth in the income account / benefit base ?
2) Your withdrawal rate from your income / benefit base?
3) Or your payout rate?
I ALREADY KNOW WHAT YOU THOUGHT HE SAID,
and chances are he probably mentioned all 3, and in the
kufuffle of the moment all those numbers sounded better than
what the current interest rates were paying at the bank,
so you signed up!
But the actual interest rate that you
are earning on your accumulation value (your real money) has
nothing to do with any of these 3 stated rates.
In the heated environment of the sales transaction, it may not have come across that way.
The rate of interest you are earning on your principal has to do with whatever index or interest choice your agent discussed with putting you into; whatever was available at the time. I can go over this subject in a different article of course.
Many clients do not realize this until way down the road and they find that their principal is declining because they are taking out more than they are earning, when in fact they were led to believe that their principal could never go down.
The agent should have clarified that your principal will never go down due to the market falling, but it certainly can decline if you take out more than you are earning.
This is a rather disingenious way of selling the annuity...and it is rampant.
If there was a 7% guaranteed rate of interest currently in the market in the year 2014, I would be a very, very, very busy man. (As it is, I may not be as busy as my fellow "line - blurrers")
But a guaranteed 7%, or 8%, or 9% rate of return, of course, does not exist, at least not right now.
By the way, an income rider should only be chosen by an annuity buyer that is genuinely concerned about an income stream much more so than he /she is conerned about the accumulation of capital. The reason for this is because the income often exceeds the interest that is being earned your money.
On the other hand, you can see that in the chart above, that if you do have longevity concerns, the lifetime payment option, especially if you can put it off (defer from taking lifetime income) for a long while, becomes quite valuable in terms of how much money you get back, the longer you live.
Your Accumulation Value
(what you have earned thus far in the policy in interest and index credits ).
The Income Account Value (Benefit Base)
(representing a fictitious numerical multiple of your principal which is multiplied by a payout factor (withdrawal rate) when you decide to start lifetime income payments.)
A famous German architect by the name of Ludwig Mies van der Rohe stated famously, "God is in the Details"..
Never before is this more true than in the discussion of annuities.