Riders Are Not Free

Retirement income annuities sold by insurance companies are the simplest, easiest and safest ways to guarantee income during retirement, but there are some secrets buried in the annuity contracts that potential buyers should be aware of before they buy.

Selling annuities provides insurance companies with a long-term -- if unspectacular -- flow of profit, but that’s not enough for some companies. Not content with a fair profit earned from issuing and backing basic income annuity contracts, many insurance companies have taken to adding a complicated and confusing array of riders that promise (but rarely deliver) increased benefits for the annuity holder. What these riders doguarantee is that the insurance company will enhance its profits through increased fees and charges paid by the annuity holder.

Don’t get me wrong, I believe income annuities can serve as a critical foundation for any individual’s plan for a comfortable and secure retirement. And there are scores of insurance companies offering high-quality annuities structured to provide a safe, guaranteed income. But, from the standpoint of the consumer, the emphasis should be placed on the basic income guaranteed and not on the potential of non-guaranteed future benefits offered in the form of costly riders that may never come to fruition.

Riders don’t ride for free - Admittedly, some of these riders may have benefits, but remember-- they are not offered out of the altruism of insurance companies. They come at a cost, and the only party guaranteed to benefit is the insurance company. By definition, these riders are tacked onto the basic income annuity contract, promising the potential of increased benefits under certain circumstances. The problem is that these riders are often complicated and difficult to understand, and it is nearly impossible to determine their real value -- if there is any. In addition, the (sometimes hidden) costs and fees are ongoing and can reduce the basic income provided by the annuity.

Here is one example: Companies like to offer what is called an inflation rider, promising to increase the income of an annuity predicated on the effect of cost inflation over time. This is a good idea, because $1,000 of income today may not be worth as much 10 or 15 years from now. The catch is that the cost to add this rider will reduce current income, and there is usually a cap as to how much the income can increase due to inflation. Insurance companies are happy to sell this inflation rider because it increases profits, and the cap on any increased future income paid out significantly reduces any risk to the company.

How can you avoid being taken for a ride? - An individual considering the use of an annuity to provide a substantial source of their retirement income (not a bad thing to do) should shop and compare different annuities based solely on the basic guaranteed income they will provide. It’s like Dragnet’s Sgt. Joe Friday used to say: “Just the facts please ma’am.” (If you are old enough to know who that is, then you are ready to retire.)

Once the fundamental value of the annuity -- to provide guaranteed income -- is established, you can consider various riders offered by the company. Using the base income as a starting point, it is much easier to identify the cost of the rider (fees for the rider are usually deducted from the monthly income) and be in a better position to determine if the potential benefits of the rider equal its cost.

This approach to buying a retirement income annuity may not be what the insurance companies want you to take, but it is your money and your retirement. Only by breaking the income annuity down to its basic intent -- providing income -- and then considering any riders that may offer a potential benefit that you are willing to pay for can you make sure you are not being taken for a ride by an insurance company that is motivated to sell as many add-on riders as it can.