Annuity income riders, new cars and the total benefits of ownership
By Jason Kestler
Kestler Financial Group, Inc.
Let’s assume you are in the market for a new car, and you have narrowed it down to two choices. Both cost the same and come from well-respected manufacturers with great service plans.
The red car comes with a shiny hood ornament and has great TV commercials. The blue car has no hood ornament but has additional safety features like seat belts, air bags, a back-up camera and anti-lock brakes. It’s a tough choice between the practical safety features that may only protect “those other people” who may be involved in an accident and the shiny hood ornament that strokes your ego daily.
Seeing your struggle, your (much smarter) spouse decides to do some homework on both cars. Knowing you typically trade in cars every five to seven years, she/he checks on historical trade-in values on both models at the end of seven years. The Internet research uncovers some interesting facts.
Owners of the red model all report that the shiny hood ornament has rusted and fallen off within the first couple years. In addition, the Blue Book value on the seven-year-old versions of this car is $0.
The blue car model shows a Blue Book value at 75 percent of the original purchase price, and postings from owners often say, “I’ll drive this car until the day I die.”
Which car would you buy?
Although this is an extreme example, it helps describe what we see going on with income riders today. Way too many advisors are focused on “shiny objects” like the step-up rate or income at age X. And, just like in the car story above, they often make decisions without checking out the “trade-in value” of the annuity.
It's important to consider the total benefits of ownership, taking into account the lifetime benefit of an annuity with an income rider.
Unfortunately, many advisors are distracted by the “hood ornament” of a high initial income or high step-up rate and ignore the total lifetime benefit to the client.
Advisors often lose sight of the fact that when a client begins taking income from their annuity, they are taking their own money first. The insurance company is providing no magical benefit. As withdrawals are taken out of the policy, interest credits attempt to replenish the account. If the underlying engine is a poor performer, the account can be depleted very rapidly.
Once the client has spent all their own money, the insurance company steps in to maintain the lifetime income. The sooner the company has to step in, the sooner the client loses flexibility and funds for emergencies. More importantly the death benefit (trade in value) becomes $0.
The overall idea is to look at the entire transaction, not just one part; to compare total dollars in to total dollars out. This gives the advisor and client all the tools necessary to make an informed decision on a product.