Index annuities for retirement income provide investors with a few significant benefits. These include:
- Low fees relative to other types of annuities (such as variable ones)
- Potential for appreciation over time
- Lifelong income
- No volatility in down markets
- Liquidity options
This makes them a terrific option for those investors who are looking for security, safety, flexibility, and income in retirement years. At the same time, they are not ideal for every person in the annuities market. We look in more depth at the inner workings of such “hybrid annuities” along with the pros and cons of these vehicles in this page.
Why Are These Particular Contracts Called Hybrid Annuities?
The Index Annuities for Retirement Income have been called Hybrid Annuities in the past. The nickname hybrid income annuity was really a marketing phrase. This was applied to those annuities contracts that roll a number of different benefits and advantages into a single contract.
The idea was to merge the optimal features of various kinds of annuities into a single package. The new benefits that were previously unavailable are now an appealing choice to many retirees and those preparing to retire.
There are a number of widely held ideas about such Hybrid Annuities, many of which prove to be either only partially true or even somewhat misleading. These include the following:
- Eight percent returns – the fact is that eight percent advertised rates often do not mean real eight percent growth
- Guaranteed income – comes with a number of well-hidden costs and fees in exchange for receiving it
- Income amounts sound very appealing – but there is a big difference between the concepts of actual income and real account value
- Commitment costs – the advertised commitment and the true longer-term commitment are two vastly different ideas with these products
The greatest single use of such Hybrid Annuities is for gaining retirement income. Ironically this is not the smartest and most efficient method for utilizing the annuity period. The reason for this has to do with income rider fees.
Typically they can consume substantial amounts of the invested principal. It means that they often negate many of the gains in a given contract. In the end, many buyers of these particular contracts find that they have exchanged actual account value for substantial income account values.
At the same time their income values are growing and accruing (and even having bonuses awarded), the actual account value is often stagnant or even decreasing. This impairs the account value at the expense of the income value.
It is critical to understand that while Fixed Index Annuities do well in times of extreme market volatility, the hybrid nature of the Index Annuities for Retirement Income means that high costs and greater complexity are a part of the contracts too.
Something else to keep in mind when considering these Hybrid Annuities is that it takes a great amount of time for the index annuity’s value to increase when it is income-centered. Meanwhile, as individuals are waiting for this factor to take effect, they are long-term locked within the eventual outcome.
It explains why those who value flexibility in retirement investment vehicles should contemplate only using the Index Annuities for Growth. They can side step the income rider altogether. When the owner has needs to withdraw money from an Index Annuity, he or she can use an annual withdrawal period to do so.
This graphic below demonstrates the real differences between the different types of annuities:
How Index Annuities for Retirement Income Work
The specifications of these Index Annuities for Retirement Income provide the potential to earn greater returns by participating in appreciation of the equities markets. These Hybrids also deliver the following advantages in one neat package product:
- Lifetime income – while avoiding any volatility in markets.
- Emergency liquidity – in times of need
- Home based health care – accelerated payouts for pressing needs that arise
Actual investments from this Guaranteed Lifetime Income Rider will be made conservatively. The insurance company that issues it will invest the earnings so that part of the gains go into an option on a market index. This could be the Dow Jones or the S&P 500 as as prime examples.
An interesting case study is the country’s top selling annuity. Allianz offers this 222 which has become the dominant annuity available. Its popularity is due in large part to the massive bonus that has topped out at 30 percent in some cases. Beyond this it provides holders with an additional 50 percent of all interest that the insurance company credits each year.
This sounds impressive, but as with anything in life there is no such thing as a free lunch. Understanding this particular Index Annuity for Retirement Income is easiest by comparing it to Social Security. The longer a retiree waits to take it, the more he or she will receive.
In this particular example of the Allianz 222, holders obtain a greater amount of income if they are willing to wait for 10 years.
Account Value Versus Protected Income Value
There are two concepts that some annuity buyers have trouble differentiating with these Index Annuities for Retirement Income. Investors can not have a firm grasp of the subject unless they understand the important subtleties of Protected Income Value and Account Value.
- Protected Income Value – refers to the premium an annuity holder invested added to the amount of the premium bonus. This amount is then increased by the sum of the contract’s interest earnings which also receive a 50 percent annual increase as bonus. The final total is what the insurance companies rely on to figure up the total in guaranteed lifetime income the annuity owner will get.
- Account Value – this equals the invested premium added to the contract term’s interest earnings.
Put simply, the owner has the account value. The Protected Income Value is only a factor relied on to determine the resulting retirement income paid by the insurance company.
Index Annuities for Retirement Lifetime Payout Options
These Hybrid Annuities have another advantage. This is options for lifetime payout that does not require the annuities holder to annuitize assets.
Insurance companies determine how much the amount of lifetime income will be by setting up an income account from the money deposited to this special account. A longer amount of time for the investments in such an account to “work” means that the income payout ultimately will be larger.
As these annuities’ holders begin to draw on their lifelong income, the insurance company will use their payout rate to determine the amount of income for life. Consider this example on an account that began with $50,000. At a seven percent income fixed each year over 10 years this income base increases to approximately $100,000.
Payout rates vary from one case to the next. This mostly comes down to the age at which the income starts paying. If as an example the payout rate amounted to six percent, then this would mean the annuity holder gets $6,000 each and ever year until he or she dies. This income will remain consistent so long as the annuity holder lives, even when the account declines below $0 value.
Who Buys Index Annuities for Retirement?
Individuals who are interested in having a dependable, steady, reliable stream of income in retirement are the ones who buy these Index Annuities for Retirement.
In particular, purchasers of Hybrid Annuities like these are those investors who are most interested in the lifelong income, potential for appreciation, no risk or volatility, long term home care benefits, and helpful liquidity options. This is ideal for those investors who are earnestly seeking security, safety, flexibility, and dependable income during retirement.
How Does Interest Get Credited?
Interest becomes credited in a variety of ways with these Index Annuities for Retirement. Going back to our Allianz 222 example from earlier, we gain some valuable insights from this most popular of annuities contracts on the market. Allianz eloquently puts it this way:
“The premium bonus and interest bonus are credited only to the Protected Income Value. To receive the PIV, including the bonus, the contract must be held for at least 10 contract years, and then lifetime income withdrawals must be taken… Because this is a bonus annuity, it may include higher surrender charges, longer surrender charge periods, lower caps, higher spreads, or other restrictions that are not included in similar annuities that do not offer a bonus feature.”
Pros of Fixed Income Annuities for Retirement
There are several positive features and advantages to these Fixed Income Annuities for retirement. They are as follows:
- Guaranteed income rider is free – the contract rider does not charge fees. Even if an account holder leaves before the bonus accrues after 10 years, there was no cost to participate
- Early death benefits provision – if the annuity holder dies early in the payout period, then surviving heirs will receive any value that remains to the account. This is dramatically different than with other types of annuity contracts
- Provision to increase income – means that Long Term Care expenses allow for the income payouts to become larger as needed
- Signing bonus potential – some of these particular annuities provide a signing bonus that credits to the Income Account
Cons of Fixed Income Annuities for Retirement
There are also some downsides to these contracts that ensure they are not right for everyone. Consider the following disadvantages to Fixed Income Annuities for Retirement:
- Restrictions on bonuses – provided bonuses constantly include significant restrictions that often are not detailed by the seller as they explain the contract
- Bonus benefits time limitations – bonuses do not accrue to the account for 10 years
- Account value stagnation – bonuses serve to grow the potential income but never the value of the account
- Partial surrenders – mean that any redemption done before the 10 years have elapsed will cause the Protected Income Value to be appropriately reduced
Final Thoughts on This Type of Index Annuities for Retirement Income Contract
Another way of looking at these Index Annuities for Retirement Income contracts is that they are essentially performance-based guaranteed income contracts. They include lower growth rates (than some annuities’ types) because as much as 50 percent of the earnings in income will be added directly in to the Protected Income Value.
Here at DCF Annuities we are happy to help with any questions that you may have. Please contact us today for more information or to speak with a representative by phone or through email.