There are many reasons people buy annuities, but the main intent is to provide retirement income. Money that is positioned into an annuity grows on a tax deferred basis and often can be turned into an income stream that will last for a person’s entire life. Fixed annuities and fixed indexed annuities also offer safety from fluctuations in the stock market.

As people age and become closer to retiring, some tend to become less concerned with achieving above average gains in investments that can have higher risk and more concerned with preserving their funds and getting a reasonable rate of return. Fixed annuities and fixed indexed annuities offer safety from market volatility.

Another important thing on retired people’s minds is cash flow planning. When a person retires they tend to become less concerned with the gains they achieve on their money and more concerned with the amount of money they can safely withdraw on a monthly basis without ever running out of money. An annuity can ease a retiree’s mind by providing monthly income that is guaranteed to never stop as long as a person lives¹.

When used correctly, an annuity can be a very attractive retirement income planning tool. When used incorrectly, an annuity can limit a person’s access to their funds and cause financial hardship. For that reason it is important to consult an experienced and trusted insurance agent or financial adviser when structuring a retirement strategy using annuities.

1. Lifetime income received from annuitization or use of an income rider can have limitations. Taking liberties such as additional free withdrawals or surrenders can adversely affect lifetime income payments. It is important to make sure your insurance agent or financial advisor clearly explains the limitations on lifetime income payments.

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The most recent buzz in the annuity marketplace surrounds the use of so-called “hybrid annuities” to obtain safety, reasonable returns, and lifetime income. The term “hybrid annuity” has been made popular by a series of online videos which are designed to give some insight into the features of these insurance products and generate interest in using them as a retirement vehicle.

What is a hybrid annuity?

So what is a hybrid annuity? Basically it is a fixed indexed annuity that includes the use of an optional income rider. Coupling an optional income rider with a fixed indexed annuity can indeed offer some very attractive benefits to retirees.

Let’s examine why some retirees like this concept. First of all, the fixed indexed annuity itself can be attractive as a vehicle to grow retirement funds and offer potential gains higher than the rates offered by more simple fixed annuities. In a fixed indexed annuity there are several interest crediting strategies. Many of these strategies allow funds held within the annuity to participate with the growth of a market index (such as the S&P 500) up to a certain limit or “cap.” When the index goes up, the annuity value can grow, but when the market declines gains are locked in¹ and the annuity’s value does not decline. This concept alone can be attractive, but let’s take a look at how an income rider can offer lifetime income.

An income rider is an additional feature that is optional on many annuities. Think of it as an optional feature that can be added when purchasing a new car. When you are buying a new car your main concern is probably ensuring the car runs and drives properly. In addition to the functionality of the car, you may want additional comforts such as air-conditioning, leather seats, or 20-inch rims. The income rider on an annuity offers some additional attractive features and, like in the car example, these features may come with an additional cost (e.g., annual fees).

Why would someone pay an annual fee to have an income rider? In a lot of cases the income rider is the primary reason for the purchase of the annuity. Income riders allow an annuity owner to convert their annuity into a series of monthly or annual distributions that are contractually guaranteed to continue for a person’s entire life. Income riders can also guarantee lifetime income for both lives of a husband and wife. An annuity income rider also offers the ability to convert an annuity into lifetime income without losing control of the underlying annuity account value. This is referred to as “avoiding annuitization.”

Why is avoiding annuitization important? Years ago when annuities were converted to lifetime income the term was “to annuitize” the contract. This meant a person or couple could begin taking lifetime income, but they had to give up control of their annuity account value. Now, with the use of income riders, a lifetime income is available but the income distributions are treated similar to withdrawals from the contract and the owner retains rights to the annuity contract value².

At Montana Life Group we avoid using the term “hybrid annuity” as it is not officially recognized by insurance companies. That said, the use of income riders in conjunction with fixed indexed annuities can be a useful concept in building a retirement income plan depending on the client’s needs. Whether you are working with a Montana Life Group agent or another insurance agent or financial advisor be sure to ask for a full explanation of fees and provisions built into the annuity and income rider.

1. Interest credits are typically locked in after a 12 month anniversary period with most strategies but not all strategies. It’s important to ask your insurance agent or financial advisor exactly how different interest crediting strategies are designed to perform.
2. Rights to the contract value are still subject to the provisions of the contract so it is important to take into account withdrawal limits, surrender charges, and how additional withdrawals will affect future lifetime income payments.

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