Surrender Penalties, Free Withdrawals,
and Income Riders

Welcome Back

Hey there, and welcome back. I'm Al Abarroa. This is the Annuity Crash Course. There are a lot of people out there with a lot of different opinions about the best way to make it through retirement without running out of money — when most investors just want to earn a reasonable rate of return without getting caught in punishing stock market volatility.

I personally believe that there is no better way to attain peace of mind than by keeping the financial planning process as simple as possible — by taking an income and growth-based approach. Annuities may not be for everybody, but their unique ability to offer principal protection — so investors never lose money — makes it easier than ever to live the dream of retirement in a way that you never thought possible.

Today I want to get into some of the more technical concepts about annuities. Let's discuss surrender penalties, free withdrawals, and riders.

---

Surrender = Penalty

When you hear the word surrender as used in insurance speak, it really translates in plain terms to mean penalty. Surrender means penalty. I'll often use the words interchangeably, but in your mind — think penalty, because that's what it is.

After all, it's an annuity contract. If you change the terms of the contract, anytime one breaks a contract, there's usually a penalty associated with that. If you rent an apartment and you break the terms of the lease, there's a penalty. If you put money into a CD at the bank and you break the CD before it matures, there's likely a penalty. That's just the reality of buying an investment product that contains guarantees.

---

Why the Time Commitment Exists

If the insurance company is going to provide a guarantee, they need you to provide a guarantee that you're going to abide by the contract as well. It's not that the carrier is requiring you to lock up your dollars because they're some evil empire. It's that they've made promises to you, and they'll fulfill those promises. But in order to fulfill those promises, they need to make their own investment commitments — and that requires a time horizon.

It takes time for them — and for you — to make money. Should you change the terms, the insurance carrier can't be on the hook for losing money. An insurance company that loses money can make good on no guarantees they're providing to their clients. They're willing to take their own business risks — they just can't be saddled with additional risks. I'm sure that makes sense.

---

Free Partial Withdrawals — Your Built-In Access

When you put your money with a carrier, it's not locked up in a steel box that you'll never have any access to. Investors have access through a structure commonly referred to as free partial withdrawals.

Free means no penalty and no surrender charge. Partial withdrawal means you can take a percentage — but not all — of the money out of the annuity on an annualized basis. That percentage typically ranges between seven and ten percent, and is carrier-specific.

In some cases, a carrier will allow a greater free partial withdrawal — but this may come with a rider charge. So I ask: is it really a free partial withdrawal if you've got to pay an extra fee for that? I don't think so.

---

Riders — Usually a Fee

In most cases, when you hear or read the word rider, that can be translated to the word fee. Not in all cases, but in most cases. A rider is an add-on — something you're adding to the contract, and something that will typically have a fee associated with it. It's important to understand what you're getting for that fee and make sure there is value in paying it.

---

The Income Rider — Turning Accumulation into Lifetime Income

There are more than one type of rider, but I'll give mention to a popular one: the income rider. The income rider offers a lifetime income payment to the annuitant — or a joint payout to a co-annuitant. The income is based on life expectancy, the date that the income is triggered, and how long the money has been invested. In other words, how long the carrier has had use of the funds to generate a return to fund that income.

Income can be based on a single life or a joint life. Joint life is based on two people's life measure. As you might imagine, one person as a life measure will have a higher income payout versus two people as a life measure — because the carrier assumes longevity risk across two lives. If a person lives a long life, the income will prevail regardless of investment performance. The onus is on the carrier, not the annuitant.

The question is: do you need an income rider, and is it worth paying the rider fee? In my opinion, this is not simply a yes or no. To understand this, it's wise to do some math and look at it from both the carrier's perspective and yours.

---

The Income Rider Math — A Real Example

Assume a couple is age 65 and they have an annuity with an income rider that will start to distribute $6,500 per year for every $100,000 they've allocated to the contract. This is a joint income rider — meaning the lifetime payout is based on two lives. As long as one of them survives, the income will also survive. It's very important to understand single income versus joint income.

When people hear this for the first time, they may confuse that $6,500 distribution as a return. It is not a return. It is a distribution of $6,500. When an insurance company agrees to cash flow you that amount annually, here's what's actually happening:

1. The carrier has had access to your capital to make money for themselves — and potentially for you — until the income rider was triggered.
2. Cash interest credits, if any, are added to your account and the rider fee is subtracted from your balance.
3. Once the income distribution begins: income credits are added to the balance, the income distribution is sent to you, and the rider fee is debited from the cash balance.

Eventually, if there is not enough interest credits to overcome the distribution and the income rider fee, the remaining cash balance burns to zero. However, the income prevails regardless.

Now look at this from the insurance company's perspective for a moment. The payout factor a carrier uses is based on mortality. Simple math tells us that at $6,500 per $100,000, it takes roughly 15.4 years to get your money back. If income begins at 65, the carrier doesn't have to reach into their own pocket until around age 80. If mortality is assumed at 88, that leaves 8 years — or $52,000 — that the carrier is on the hook for if there's been no investment return to offset distributions. To break even, the carrier needs to generate $52,000 on that initial $100,000 over a 23-year window. This is not a huge undertaking for them. But they have to do it while paying you annually and making money for themselves — all while contending with their own business risk.

You might think you could do the same on your own. And while that may be true, the real question is: what happens if you don't? What happens if your retirement coincides with an extended period of stock market volatility or low interest rates? What happens if 88 is conservative and you live well into your nineties? Where will that income come from?

---

The 4% Spend-Down Comparison

Most financial plans are built around a 4% spend-down. That's thought to be appropriate. Anything north of 4% tends to put enormous pressure on the portfolio and challenges its survivability — meaning you increase the odds of running out of money in retirement.

Let's look at a $500,000 portfolio of stocks and fixed income with a 4% spend-down. That generates $20,000 per year — and even at 4%, there's no guarantee the portfolio can sustain that in perpetuity due to stock market risk.

Now let's take the same $500,000 and allocate $200,000 of it into an annuity with a lifetime income rider paying 6.5%:

• The remaining $300,000 stays in the market. At 4% spend-down, that's $12,000 per year.
• The $200,000 in the annuity generates $13,000 per year at 6.5%.
• Total: $25,000 per year — $5,000 more annually, a 25% increase in income with no additional pressure to the portfolio.

Or look at it this way: if your goal is $20,000 per year from that half million, the annuity generates $13,000 of it. You only need to draw $7,000 from the $300,000 in stocks — that's just 2.3%, far less than the 4% standard. This puts significantly less pressure on the risk portion of the portfolio and reduces the odds of running out of money.

---

Three Advantages of an Income Rider

To summarize, the income rider can benefit you through three main categories:

1. Longevity — greater survivability of your overall assets.
2. Guaranteed income — regardless of market conditions.
3. An income boost — increasing your annual spend-down without adding portfolio risk.

It's a tool to reduce the burden of a 4% spend-down and offer the likelihood of greater success. That said, not all income riders are created equal. They do not all have the same annual rider fee, and they do not all have the same cost. It's of the utmost importance that you understand what the income benefit base is and how it's calculated. This is something we spend time educating our clients on — and we've found that one-on-one conversations really help cement this.

---

Conclusion

If you have additional questions, please reach out to our office. I or another member of my team will help you — you can reach us at (888) 703-2206 or by clicking the link below to set an appointment with our team.

I look forward to speaking with you soon and helping you improve your future quality of life and retirement outcomes. Thank you.