It's natural to be concerned about saving enough for retirement – but it's important to have an income strategy, too. While a fixed annuity can offer you principal protection from market downturns, potential indexed interest, and the potential for tax-deferred growth, an added income rider goes one step further. In this episode of Money Script Monday, Kevin shows you how an income rider complements a fixed annuity; providing you the perfect balance of accumulation and income while in retirement.

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Video transcription

Hey there, my name is Kevin Nuber. Thank you for attending today's, "Money Script Monday," video. Today, what I'm going to be talking about is how an indexed annuity works with a guaranteed income rider. The reason why I want to talk about this today is because, unfortunately, there is a misconception that indexed annuities are overly complicated. And any time a consumer believes that something is too complicated, they simply just do not purchase it. So the purpose of this video is to simplify exactly how an indexed annuity works. And in the end what I want to do is I want to show you that every retiree in America wants an annuity. The difference is exactly what type of annuity and where they get that annuity from. So, let's go and get started.

Two buckets

In order to explain this, what I do is I separate things into two different buckets. Every index annuity with an income rider is going to have two different buckets, two different accounts. These two buckets are completely independent from each other, they don't cross over, they don't cohabitate, they're completely separate, they're calculated separate every single year. So, what I've done is I've drawn this chart and I'm going to cover each bucket one at a time.

(1) Accumulation

So, let's assume that you have $100,000 that is going into an index annuity. On this side, we have our accumulation account. Now, every insurance company might call this something different, but we'll call it an accumulation account. And in year one, $100,000 goes into that account, pre-determined, guaranteed.

Now, what happens between now and 10 years into the future in this example? We don't know. A lot of things can happen. However, I can tell you with 100% certainty that you will have at least $100,000. What this means is that you cannot lose money inside one of these indexed annuities. You're actually going to have something greater than this $100,000, but the problem is that we really don't know what that number is going to be.

Now, there's many things that can determine exactly what this number is going to be. But the nice thing about an indexed annuity is that it's not the insurance company that's determining the interest rates in some convoluted format. You actually have something that's separate from the insurance company, it's public and it's published, and you can track it every single year to see exactly how your interest is going to work.

You see, you can pick up a newspaper, it's as simple as this, you pick up the newspaper and you look for the index that you've chosen. It can be an index like S&P 500 or the NASDAQ index. And you can, through the newspaper, you can actually see each year how much you're going to earn. Now, there can be caps and things to how much you can earn, but every single year, year one through 10, you're either going to earn a positive amount, or you're going to earn zero. You can never lose any money.

So, although we cannot tell you exactly how much money you're going to have after 10 years, for the purpose of this example, we're going to assume that you have $130,000. You could have more, you could have $150,000, $180,000, but you can never have less than $100,000.

That's as simple as an index annuity is. It's as simple as that, there's nothing more to it. Now, different products might have different bonuses or indexes and things like that, but this example is the same for every single indexed annuity.

(2) Income

Now, onto the income side, remember this is an account that's completely separate, it's calculated separately and it's calculated on an annual basis. This income account is the money that you're going to use for a guaranteed income in the future. This money over here on your accumulation side, this $130,000, is the amount that you can go cash out and buy something with, it's real money. This side is the money that you use for a guaranteed income stream in the future. For this example, this particular product that I'm describing has a $100,000 going into this income account, and this is going to have a 15% bonus which means that you'd start with $115,000, guaranteed.

Now, again, between year 1 and 10, we don't know exactly how much you're going to earn each year, but I can tell you that at the end of 10 years, you're going to have nothing less than the $115,000 that went in, and you're probably going to have something much greater on this side. And this example, we're using $225,000.

We don't know what it's going to grow to, but I can tell you exactly how the calculation is going to work. The calculation works identical to this side of the equation except that you have a 50% interest rate bonus. To simplify this, this means that if you earn 3% on your indexed account, then you're going to earn four and a half over here in your income account. You earn 5% over here on this side, and on this side you earn 7 ½%, and if you earn 10% on this side, you earn 15% over here. So, you're always going to have a much, much greater value on your income side than you are on your index side.

For the purpose of this example, we're going to assume that your income account is going to grow to $200,000. So, at the end of 10 years, you're going to have an option, two options. One is to cash your annuity out. And if you do it, you can walk away with $130,000 and you can spend that money on whatever you want to spend it on. However, if you choose to take a guaranteed lifetime income, that's going to be guaranteed for the rest of your life no matter how long you live, then the insurance company is going to use this number, the $200,000, in order to calculate that guaranteed income.

On this particular product, the insurance company multiplies it by 5% so your income is $10,000 per year. Every year that you earn a positive index credit, that income will increase by that amount. So, the next year it could be $10,500, then $11,000, and so on. That again is going to be a guaranteed income for the rest of your life.

Three Forms of an Annuity

So hopefully, this simplifies exactly how an annuity works because in the end, everybody wants an annuity when they retire. As I said in the beginning, it just depends on where they get that annuity from. So really, there's only three places that you can buy or actually get any sort of annuity from, and I've listed them here.

(1) Social Security

Anybody who's worked in the United States for a certain amount of time is going to get social security from the United States government, and this is nothing more than an annuity payment from the government. So all of us, as retirees, are going to get an annuity in the form of social security.

(2) Private Pension

Well, what about people who need more than social security, or what about people who worked for a company for their entire life? Well, those people might get a pension from that company.

A private pension from a corporation is, again, an annuity and instead being backed by the federal government, a private pension is backed by corporation. Now, we all know people, I do, who have both social security and they have a private pension. And I know that those people are pretty set for life in the form of guaranteed income, they have plenty of guaranteed income. So, what about a person who needs more than social security? And what about a person who did not work for an employer that provided them with a private pension?

(3) Lifetime Income Benefit

Well, in that situation, the only other place you can get a guaranteed income for life in the form of an annuity payment is from an insurance company in the form of an annuity. A lifetime income rider such as an index annuity is a great way or a great place to get that. So, an absence of a sufficient social security and an absence of a private pension, the only other place you can get an income for life is from an insurance company.

So, a majority of the people who retire in America, they want to purchase an annuity and they have to buy it from an insurance company. So hopefully, by simplifying exactly how an indexed annuity works, specifically, with an income rider, it will make all the people watching this video more comfortable purchasing an indexed annuity from an insurance company.

Thank you very much for watching today's, "Money Script Monday," video. My name is Kevin Nuber, have a great day.