Why your ‘high-interest’ annuity might pay less than you think
Too many people that own an annuity with an attached income rider believe they somehow have procured a high-interest-rate product in a low-interest-rate world. Nothing could be further from the truth.
Taking a ride on the rider dream
Most of the annuity ads you see on TV or hear on the radio mention interest rate type numbers as high a 7% or 8%. These ads are intentionally vague, and allow the listener and viewer to fill in their own blank. Anyone with a rational brain knows that with 10-year Treasury rates at less than 2.5%, there is no way someone can offer 7% or 8%. Tragically, that doesn’t prevent annuity promoters to “suggest” you might be able to get a high interest rate with their income rider product.
I recently spoke to an industry leader and publisher of a popular industry blog, and he believes that three out of every four people that have an income rider thinks that annual rider percentage is a true yield like you would receive on a CD or a bond. I think that the number of “annuity dreamers” is even higher, and a sign that there could be legal troubles ahead for the annuity industry and the inappropriate way most income riders continue to be sold.
By the way, anytime you hear the made up word “hybrid” or “hybrid annuity,” all that means is you are buying an annuity with an attached income rider. This is a great example of why the annuity industry has earned its bad reputation. Agents can say or promise anything to get the sale.
Separate calculation reality
With deferred annuities like variable and indexed that have income riders attached to the policy, the accumulation value and rider value are typically a separate calculation. The difference between the two is that the income rider calculation can only be used for income. You can’t peel off the interest, transfer that amount, or get to the total in a lump sum.
An easy way to remember how this works is to draw a line down the middle of a blank sheet of paper. The left hand side of the ledger is the accumulation value. This would be the mutual fund (i.e. separate account) calculation for variable annuities, and the index option value for indexed annuities. The right hand side of the ledger is the income rider calculation that is for income only. Two separate calculations with two separate contractual rules.
Actuarial genius doesn’t exist
With interest rates at historic lows, annuity carriers don’t have some financial genius locked in a room that has figured out how to guarantee 7% or 8% rates. Unfortunately, both agents and carriers allow that line to be blurred so that many uninformed and non-savvy annuity buyers believe that Jimmy Carter era rates have miraculously returned via income riders.
If the annuity industry wanted to clear up all of this confusion, it would be a very easy message to convey and clarify for the buying public. The campaign would be all of six words: “Income riders are for income only.” Common sense anyone?
Rules of the game matter
Income riders do have their place when planning for future income or what I call “income later.” The key is to know the rules of the game and the actual way the income rider works within the policy.
The bottom line is that income riders and their valuations are typically like monopoly money unless it is used for income. That’s not a bad thing, just a fact that too often isn’t fully explained or understood.
Originally published 12.16.14 by MarketWatch.com – http://www.marketwatch.com/story/why-your-high-interest-annuity-might-pay-less-than-you-think-2014-12-16