Lifetime Income Benefit Rider Vs. Annuitization

So, you're looking for income and want to know the difference between a lifetime income benefit rider and what's called annuitization. Annuitization means creating payments. Now, with 10,000 baby boomers retiring every single day, most people are looking for income. Most people are looking for contractual guarantees. They're not looking to trade the markets and be Gordon Gekko. They want to ensure they have a solid guaranteed income floor in combination with their Social Security, pensions (if you're fortunate), dividend income, rental income, or whatever else you have coming in every month, guaranteeing that lifestyle you want to live.

Let’s talk about lifetime income benefit riders versus annuitization. Before we get into that, we’re going to cover a lot, and I’ve written two books on the subject. I’ve written several books, but these two cover what we will discuss today. They address your concerns and the details you need to know.

Income Rider Owner's Manual & Immediate Annuity Owner's Manual

I've written an Income Rider Owner’s Manual, which covers all income rider types, how they work, their benefits, limitations, etc. I also have an Immediate Annuity Owner’s Manual, which is the granddaddy of all annuitization products. It’s a lot of information, so at the end of this blog, I’ll tell you how to get those books for free. There is no cost, no obligation—just good, reliable information. We won’t call you, and we won’t bug you. We'll treat you like a professional, and hopefully, we can be your agent of choice when the time comes—or if not, that's fine too.

Understanding Income from Annuities

So, let's talk about income from an annuity. Any type, whether it’s an Income Rider or annuitization, is a combination of return of principal plus interest. That lifetime income guarantee is based primarily on your life expectancy, or if it’s set up joint with a spouse or someone else, their life expectancies at the time you take the payment.

There’s a lot of talk in the media about rates and timing rates, and interest rates do play a role in lifetime income guarantees, but it’s a secondary role. The primary pricing mechanism—the thing that drives the train—is life expectancy. Just remember that because you can’t time it.

What is Annuitization?

Let’s talk about annuitization. Annuitization, the creation of payments, started in Roman times. That’s when Immediate Annuities were first introduced, and those are the granddaddy of all annuitization products. Again, return of principal plus interest is based on your life expectancy. The value proposition is that the annuity company will pay you for the rest of your life, regardless of how long you live. If you live to 150, they’ll pay you to 150 and continue to pay you even if there’s zero in the account.

Annuity Taxation Overview

Now, let's talk about annuitization from the standpoint of taxation. I’m not a tax advisor, but here’s a broad overview of how it works. All annuities can be used inside an IRA, outside of an IRA, or inside a Roth IRA—whatever you choose for the contractual guarantees. The taxes will depend on which account you choose.

Let’s look at annuitization outside of an IRA. Inside of an IRA, everything coming out is fully taxed as ordinary income. Immediate Annuities outside of an IRA (non-qualified account) follow a combination of return of principal plus interest. When we send you a quote, there will be a column showing your guaranteed monthly amount, the portion that’s not taxable, and the taxable portion.

The taxable portion is the interest part. In our business, we call this the exclusion ratio. As long as the money lasts, the exclusion ratio will be applied. So, you’ll only pay taxes on the interest portion of that income stream. When the account goes to zero, and you’ve outlived your life expectancy, it becomes taxable.

Annuity Taxation Breakdown

Let’s go over that again. Until you’ve used up all the money, the exclusion ratio applies, and you’re only paying taxes on the interest portion. Once the account is exhausted, everything is taxable. But it doesn’t really matter because the annuity company is on the hook to pay you even if you live to 150.

Lifetime Income Riders: A Bit More Complex

Let’s talk about income rider payments for lifetime income. This is a bit more complex because there are numerous types of Income Riders. Let’s talk about the ones that are not annuitized. Some are attached to Variable Annuities and can be annuitized. We’re getting in the weeds here a bit, which is why you need to get my book, as I cover those in more detail. However, the majority of Income Riders being pitched today are not annuitized.

You might ask, "Stan, how can it be a lifetime income stream if it’s not annuitized?" An Income Rider pays you for life, but in essence, it’s a withdrawal. They’re subtracting from the account and paying you for life, but it’s not the same as annuitization. It’s not a combination like the exclusion ratio. Most Income Riders and I say that broadly, are structured to use last in, first out (LIFO) accounting, meaning you’re paying taxes on the gains first.

Comparing Annuities and Income Riders

Does this make annuitization better or worse than an income rider? No. In my world, it’s all about contractual guarantees. I only focus on the will do, not the might do. The will do is the contractual guaranteed part. If you want income—whether now or in the future—I’ll quote all products to see what offers the best contractual guarantee.

I got a call the other day from a gentleman who said, “Hey, I want income in seven years.” I said, “Great. Are you using IRA or non-IRA money?” He said, “non-IRA.” Perfect. So, we quoted all Income Riders, and we also quoted a Deferred Income Annuity, which is an annuitized product. When the quotes came back, we had a conversation, and I explained the differences.

How to Choose Between Annuities and Income Riders

Here’s the bottom line: With the Income Rider, all of that income stream is taxed, LIFO (gains first). With the Deferred Income Annuity, a portion of the income is not taxable because we’re using non-IRA assets. You need to weigh which option makes more sense for you in terms of time, value, and money. For non-IRA money, we’ll look at both options and consider the taxation of the income stream, which is very important. From there, you can make a decision.

Interestingly, the gentleman ended up buying one Income Rider and one Deferred Income Annuity—a pretty interesting way to go about it.

Final Thoughts

There’s no perfect answer out there—just bad sales pitches. Never forget that. No one has the perfect solution. What we do is show you the best quotes, give you the best information, and explain everything, then leave you alone to make a good decision.

So, where do lifetime income benefit riders and annuitization fit? They’re for income. If you need income, you need a lifetime income guarantee. That’s the unique benefit proposition that only annuities have. When you see people on TV and radio saying, "I hate annuities," ask yourself: Do they hate lifetime income? The answer is no. There's an agenda behind that pitch, and it’s a very good one for them to get business, but they know better. People love their Social Security payments and pension payments, and they’ll love their Income Rider or annuitization payments because they can never outlive them.

Making Your Decision

If you’ve worked hard for your money, you deserve to understand how these lifetime guarantees work. There’s no perfect solution, but both products work well—they just have their limitations and unique benefits.

I hope I’ve answered some questions and solved some problems for you. I encourage you to dig deeper. I release content every single workday to help educate everyone out there.

Getting the Books

To get the books, click this link to download them for free. We want to educate you. If you decide to move forward and get a quote or talk to us, you’ll know exactly what you’re buying.

Remember, there’s never an urgency to buy an annuity. The urgency is for you to understand them on your terms and your timeframe. Thanks for reading along, and I’ll see you next time!