The 10% Return That Isn’t a Return
Understanding the Number That May Determine Your Retirement Paycheck… Even Though You Can’t Cash It In!
“My annuity is guaranteed to grow at 10%!” I’ve heard that from clients in my office, said proudly and confidently. They’re sure they can show me on the paperwork. And my first question back is always the same…
“Which value?”
Clients usually respond, “What do you mean?” Most annuity statements show several values, but clients often focus on the largest one and assume it is the amount they actually have.
Here’s an example of an FIA statement with an income rider…
“Which of these numbers are actually mine?”
Confused? You’re not alone! Let me say something first, because it matters. If you own an annuity with an income rider, owning one does NOT mean you did anything wrong. It may be exactly the right tool for you.
In fact, we recently met a client, Giselle, who had purchased an annuity with an income rider but didn’t even understand that was what she owned. When she realized she didn’t have that much money, she felt “taken.”
In actuality, when we put her plan together, it fit nicely into Income Pipeline #3! (Future Guaranteed Income: Newsletter [#026]) We told her this was perfect for her plan, and we incorporated it into her solid income plan for the future.
Since it takes time for the Income Rider value to grow, the fact that she purchased it 10 years ago means it’s “ready” for her plan.
Was she disappointed she didn’t have as much money as she thought? Yes, but very happy that it’s going to provide ~$1,300/mo. supplemental income for life! With her Social Security, she’s ready to retire with a “base income” she can rely on, while investing other IRA money.
A “tool” that solves the problem is the RIGHT tool! She didn’t buy it for that, and the advisor who sold it to her didn’t include it in a plan, but we made it work!
This is also an example of what a true “Fiduciary Advisor” does. As Fiduciaries, we are “agnostic to the tool”. It didn’t matter that we didn’t provide the tool. Unfortunately, all too often we see advisors advise new clients to “cash in” everything, so they can sell their own products.
Now I’m not saying they’re just trying to make money off the client. Some of them don’t know how to analyze products you already own and use them in a comprehensive plan. This is when it’s up to you to do your own due diligence.
The trouble starts when nobody shows you which number on your statement is actually yours to spend, and you falsely believe your actual $$$ are growing!
Today, we fix that.
Last week, in [#028], we looked under the hood of a Fixed Index Annuity (FIA) and its first job: accumulation. You learned that you’re NOT invested in the index (it’s a measuring stick), and that a 0% floor means you don’t lose money when the market goes down but doesn’t mean the contract can never lose value. If you missed it, go back and read it first. This issue sits right on top of it.
I also promised you something that sounds like an account growing at 7%, 8% or even 10%… while your actual money may not be growing at that rate at all.
Welcome to the World of Income Riders!
Beware the Headless Rider: What Annuities Aren’t Telling You
Today is the FIA’s second job: turning a pile of money into a paycheck. And one question:
When someone says your annuity is “growing at 10%”…
So What’s Growing at 10%?
An FIA can come with an Income Rider. That’s an optional feature, sometimes free, sometimes added for a charge, that provides a defined income, often for life, usually in the future.
And once you add one, your contract can show you two very different numbers.
Account Value. This is your REAL money. Your deposit, plus any index credits, minus withdrawals and charges. It’s what you could walk away with (less any surrender charges if you’re still in the surrender period). And when you die, it’s usually what your heirs receive.
Income Benefit Base. This one is a calculation number, used for one job only: figuring out how big your paycheck will be. You generally can’t withdraw it as a lump sum, and it’s usually not what your heirs receive.
You can’t cash it in!
Last week, the index was a measuring stick. This week, the Income Benefit Base is ANOTHER measuring stick!
Let’s translate that…
Think of it like airline miles. They show a big number on your statement… but try paying for groceries with them. You can only use them the way the airline lets you.
So the 10% you heard about? It’s probably the “roll-up rate”, and the roll-up grows the Income Benefit Base
Your Account Value still plays by the rules we covered last week: caps, participation rates, spreads, and a 0% floor.
This is a real example of an FIA with an Income Rider issued in 2010, and the values in 2019:
Pro Tip: Pull out your annual statement right now. Look for more than one value, with words like “Account Value,” “Surrender Value,” “Income Base” or “Benefit Base.” Circle each one. If you can only find one, call the insurance company and ask for the others. It’s YOUR contract. You’re allowed to ask!
Let’s Put Round Numbers On It
(Sorry about the math. I was originally a 5th grade math teacher, so you’re getting the chalkboard version.)
Hypothetical, for illustration only. These are made-up numbers, not a real contract.
- You put $100,000 into an FIA with an Income Rider at age 60.
- The rider’s “Roll-up Rate” is 10% a year, figured on your original deposit for 10 years
- You wait until 70 to turn on the income
At 70, your Income Benefit Base is $100,000 plus ten years of $10,000 each. That’s $200,000.
“My money doubled!”
No!
Your “Account Value” spent those same ten years doing exactly what we described last week: Interest Credits in the up years, 0% in the down years, minus any rider charge. Let’s say it landed at $130,000.
So your statement at 70 shows two numbers:
- Income Benefit Base: $200,000
- Account Value: $130,000
The $200,000 is real, but it’s not money you can spend. It’s the number your income gets figured from.
Those were my made-up numbers. Here’s a real one.
The statement we saw at the top of this newsletter is an excellent example to dissect:
(Note: This is NOT Giselle’s. This is an actual statement from Gloria’s case we mentioned in [#025])
Let’s look at the “real money” vs. “fake money” (Income Rider Value).
Notice Gloria deposited $155,981.30 about 9 years earlier…
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The “real money” value: $199,075.17.
- That’s certainly NOT a 10% growth!
- If you calculate it, it’s only 2.75%!
- The actual money she could take back at any time
The “fake money” value: $311,182.73!
- If that were a return, it would be 7.98% a year. It isn’t…
- It’s the number used to calculate her “income”
- But wasn’t she promised 10%?
- Yes, but the 10% had “rider fees” withdrawn from it!
So which of these two numbers writes her check? Good question…
How Does a Number You Can’t Cash In Become a Paycheck?
Here’s how it works: The contract applies a “payout percentage” to your Income Benefit Base. That % is set based on the age you want your income to start and whether the income has to cover just you or you and your spouse.
The older you are, the higher the % (because they’re guessing you won’t live as long, they won’t have to write as many checks!).
If you want to cover both you and your spouse, the % is usually .5% less, and based on the younger spouse’s age, because they’ll have to write MORE checks!
In plain English: The “Income Benefit Base” is the pot, and the “payout percentage” is the size of the dipper coming out of that pot.
Back to our hypothetical…
A 6% payout applied to a $200,000 “Income Benefit Base” is $12,000/yr. or $1,000/mo. for life under the contract terms.
Caution: That $1,000/mo. is not a 10% return and isn’t interest. It’s a formula in your contract.
Remember Maryanne in [#027]? Her 7.4% payout rate included both earnings and return of her own principal. Same idea here.
Giselle’s statement had a big number on it that she couldn’t spend, and finding that out made her feel taken. But once we put her plan together and saw what the contract could actually do, that same number went to work!
It became ~$1,300 a month in income for life, sitting in Income Pipeline #3 (the future guaranteed income pipeline) right next to her Social Security!
She didn’t buy it on purpose for that job. She bought it, it sat for ten years, and the waiting is the very thing that made it useful. It’s true her “real” money didn’t grow at 10%, but the number that sets her paycheck did!
And now for a look at another scenario:
Gloria has no children, and her husband, who is 13 years older, already has his income covered by a separate contract.
So this money has exactly one job: Pay her for as long as she lives!
If you subtract $15,559.14/yr. from her “real money” ($199,075.17) for 6 years, that’s $93,354.84 already gone! Gloria is only 67, could she use up ALL the money?
Absolutely! And she’s looking forward to it! You see, she doesn’t have anyone she needs to pass money on to, AND she’s totally excited about the insurance company paying her out of THEIR pocket! (While she continues to invest her other money!)
Her contract says that even if her money is all used up, they’ll continue to pay until she’s gone!
Note: Not every contract keeps paying. Variable annuities are a different animal. Some carry lifetime income riders that keep the checks coming after the account value is gone, and others guarantee only a total dollar amount rather than income for life. Read the rider pages before you assume either way..
One more thing about Gloria. She liked the planning process so much that she later came to work with me. She’s my lead advisor today!
One of these she can walk away with. The other one writes her paycheck.
P.S. There’s a tax story buried in those same two numbers, and it has earned its own newsletter. Soon!
Back to Giselle…
Giselle’s statement had a big number on it that she couldn’t spend, and finding that out made her feel taken. But once we put her plan together and saw what the contract could actually do, that same number went to work!
It became ~$1,300 a month in income for life, sitting in Income Pipeline #3 (the future guaranteed income pipeline) right next to her Social Security!
She didn’t buy it on purpose for that job. She bought it, it sat for ten years, and the waiting is the very thing that made it useful. It’s true her “real” money didn’t grow at 10%, but the number that sets her paycheck did!
This brings us to our conclusion for this week. Remember the most important question to ask when considering ANY financial product.
What Problem Are We Trying to Solve?
An income rider has one job: Filling the gap between the dependable income you already have and what your life actually costs [#024], for as long as you live.
Mistakes?
#1 Mistake:
Confusing an Accumulation FIA with an Income FIA.
If you look back at the statement we showed, you’ll see that the Income Rider was great; the Accumulation was almost nil.
Why? A contract built to deliver a big, guaranteed income usually gives up accumulation, and one built for accumulation usually has a weaker rider. If someone tells you a contract is best at both, ask to see both sets of numbers.
#2 Mistake:
Unfortunately, we see this often, and the results can be disastrous! If Social Security and a pension already cover your Basic and Operating expenses, you may think that you don’t need one at all.
You’re very fortunate, but if you’re married and one spouse passes, the survivor loses the smaller Social Security check. And if you have a pension, many survivor options pay 50% of the check, and some retirees waived it entirely,
Where does this leave the surviving spouse? Expenses rarely shrink much when a spouse passes. Does the electric bill get cut in half? The mortgage? The taxes? Maintenance of the home? Tax rates on the same amount of income increase when filing “Single”!
This is a great tool to plan for survivorship!
If there’s a gap, this is one tool that can fill it, alongside a SPIA [#027], a pension option [#025] or a mix. And when we do use it, we fund that pipeline with the least amount necessary [#026], so the rest of your money is free to do its other jobs.
Whatever tool you’re looking at, the question never changes: what problem are we trying to solve? We’re agnostic to the tool. Nothing here is advice; it’s education.
We Have a Gift for You!
“Which Value? 9 Questions to Ask About an Income Rider.” One-page read to print and take with you. Five of them are the questions we asked today. The other four are next week’s.
We Have a Gift for You!
Pro Tip: Read it BEFORE you sit down with anyone’s illustration…including your own statement!
Next Week:
“Guaranteed for Life”… By WHOM?
What that promise costs you, and who is actually writing the checks.
Gloria plans to spend every dollar of her own money, and she’s smiling about it, because her contract says the insurance company keeps paying after that. So who stands behind a promise like that? What does the rider charge you every year to make it? And what happens to the money if you DON’T spend it all?
Retire Plugged In Community Update
In our community, Retire Plugged In, all of this lives in one place: short videos on income planning, taxes, Social Security and avoiding scams, right at your fingertips. When the rules change, I can send you an Alert.
Here’s the link to join the list of people who’ll be notified when we open our founding beta group:
Okay, I’ll leave you with that for now. Have a great rest of your day, and I look forward to seeing you next week.
I think that’s enough REAL for today…
Take care,
Nora
