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Step 2: Identify The Critical  Comparison Points

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Critical Comparison Point #1: Guaranteed Income Base

Does the annuity have a guaranteed number your income will be based on when you decide to take income?7

This number may be identified by various names; I have seen it called Income Account Value, Accumulation Value, GLWB (Guaranteed Life Withdrawal Benefit), Withdrawal Benefit Base, and Income Benefit Base among others. So immediately find out what the issuing carrier of the annuity you are interested in calls it. Whatever they call it, in this book I will refer to it as the Guaranteed Income Base.

The Guaranteed Income Base is one of the most critical pieces of information it is necessary to have to knowledgeably compare annuities. It may or may not be the same as the cash value of the contract, it may or may not be the same as the surrender value of the contract, and it may or may not increase on a yearly basis. In the case of a variable annuity, the Guaranteed Income Base may be the higher of the value of the subaccounts8 or the initial premium or some other guaranteed amount. Since the value of the subaccounts will not be known until income is requested, always use an amount that is known and is guaranteed. If only the value of the subaccounts will be used then use the number 0 here to indicate no Income Base is guaranteed.

To successfully compare income annuities you must know the Guaranteed Income Base for the year you expect to start your income stream or for an arbitrary baseline year you have selected for your comparison (such as Year 10). Make the salesperson show you where it shows the number labeled “Guaranteed.”

NOTE: For some annuities, a special rider9 must be added to the contract before the carrier will provide a Guaranteed Income Base. Most every carrier has a different name for these riders so find out the name of the rider on the product you are interested in. Most riders added to an annuity will have a fee associated with it. Make sure you get full information about annuity income rider comparison.

Even though the Guaranteed Income Base is one of the most critical pieces of information you will use to successfully compare annuities, it is by no means the only important number. Unfortunately, many annuities are sold simply based on this number. Investors, weary of uncertain returns, see a guaranteed “doubling of their money” in 10 short years and purchase it with the mistaken belief that they money will indeed “double” (more on this in Section C).

CASE HISTORY EXAMPLE – JIM AND JANE

The “Lifetime Max Income Rider” Jim and Jane opted for when they purchased their annuity gave them a Guaranteed Income Base of $240K at the end of Year 10. Their initial purchase price ($100K premium) will be credited with 14% simple interest (14% of $100K per year or $14K) per year for ten years. The carrier guarantees that rate and also guarantees after ten years (if no withdrawals have been made) the Guaranteed Income Base will equal $240K.

CASE HISTORY EXAMPLE - MURIEL

To obtain the Guaranteed Income Base in Muriel’s annuity the carrier will credit the initial purchase price of her annuity ($500K) with 8% simple interest (8% of $500K per year or $40K) per year for ten years. Additionally, if Muriel does not take any withdrawals within that ten year period, the carrier with giving her a “bump up” so her Income Base will equal 200% of her initial purchase price. The carrier guarantees this crediting system and also guarantees after ten years (if no withdrawals have been made) the Guaranteed Income Base will equal the higher of the value of the subaccounts or $1M.

Muriel’s Guaranteed Income Base was also made possible by a rider added to her annuity. This rider has a yearly fee associated with it.

CASE HISTORY EXAMPLE – BILL

What the Guaranteed Income Base for the annuity Bill was contemplating is the same as his initial purchase price. This is the case for all immediate annuities.

Critical Comparison Point #2: Guaranteed Percentage Payout

The second most critical comparison point you need to know is the Guaranteed Percentage Payout. This is the percentage of the Guaranteed Income Base the carrier will pay out on an annual basis.

The Guaranteed Percentage Payout will vary from carrier to carrier and will be based on actuarial tables. In other words, it will be based on how long the carrier expects you to live, with a lower payout for lower ages. Some carriers raise the Guaranteed Percentage Payout every year the contract is deferred, and some utilize a “band” system in which all the ages in a certain “band” get the same Guaranteed Percentage Payout.

CASE HISTORY EXAMPLE – JIM AND JANE

Jim was concerned because his annuity had a Guaranteed Income Base of $240K while his friend Mike’s annuity had a higher payout on a Guaranteed Income Base of $200K. He was puzzled as to how this could happen. What Jim didn’t know about, of course, was the Guaranteed Percentage Payout. When he finally figured it out, he realized the Guaranteed Percentage Payout on his contract was a mere 3.5%! And the Guaranteed Percentage Payout of Mike’s contract was 5.0%! Now, Mike was 3 years older than him and Marcy was a year older than Mike (on a joint annuity contract the Guaranteed Percentage Payout is always based on the younger of the annuitants) and Jim had no way of knowing what the Guaranteed Percentage Payout of someone his age would be on Mike’s contract but he was astounded at the difference.

CASE HISTORY EXAMPLE – MURIEL

While doing her research on annuities, Muriel discovered the annuity she purchased had banded Guaranteed Percentage Payouts. And they started quite low. The bands were for five year periods and went up ½ of a percentage point with every step up. At age 60 (the age at which she expected to retire) the Guaranteed Percentage Payout was only 3%. At that age, her $500K initial purchase price (which had a Guaranteed Income Base of $1M) would net her a guaranteed $30K annually for life10.

CASE HISTORY EXAMPLE – BILL

The salesperson Bill spoke to on the phone was quite clear. His Guaranteed Income Base would be equal to his purchase price ($107K), and the Guaranteed Percentage Payout was 5.75% (SPIAs often have the highest Guaranteed Percentage Payouts.)

Critical Comparison Point #3: Guaranteed Payout Amount

This is the amount of income guaranteed to be paid to you on a yearly or monthly basis.

The annual Guaranteed Payout Amount should equal the Guaranteed Income Base (Critical Comparison Point #1) multiplied by the Guaranteed Percentage Payout (Critical Comparison Point #2). If the figure you are given as the Guaranteed Payout Amount is not the same as multiplying Critical Comparison Point #1 by Critical Comparison Point #2, there is bad info somewhere along the line.

It might be argued one need only compare Guaranteed Payout Amounts, but I like to have the math “add up” as a system check. Additionally, I like the transparency of actually seeing the component parts of the Guaranteed Payout equation spelled out because it can give you useful information about the carrier. For example, I would prefer to select a carrier which increases the Guaranteed Payout Percentage every year to reflect the higher mortality rate. A carrier who “bands” their Guaranteed Percentage Payout may have a lower Guaranteed Payout for the more advanced ages in the band to the detriment of the annuitant.

CASE HISTORY EXAMPLE – JIM AND JANE

The $8,400 ($700/month) annual Guaranteed Payout Amount, Jim and Jane, was given equaled his Guaranteed Income Base multiplied by his Guaranteed Payout Percentage. Jim now understood how the Guaranteed Payout Amount was derived.

CASE HISTORY EXAMPLE – MURIEL

At her expected retirement age of 60, Muriel’s $500K initial purchase price (which had a Guaranteed Income Base of $1M under certain conditions) would net her a guaranteed $30K annually for life11. ($1M x .03)

CASE HISTORY EXAMPLE – BILL

With just the money he has left, Bill could receive $6,152.50 per year ($107K x .0575 = $6,152.50).

Note how the carrier can manipulate the Guaranteed Income Base and Guaranteed Percentage Payout to position their product favorably compared to other annuities. When a consumer sees a high Guaranteed Income Base, it naturally sparks an interest in the product. And it is not usually a hard sell when a salesperson focuses on the Guaranteed Income Base and gets his/her client all excited about the fabulous guaranteed “return”.12 Ditch an annuity sales adviser if s/he focuses mainly on the Guaranteed Income Base or crows loudly about the huge return you will be earning13. It just isn’t so, and your adviser is either ignorant or misleading you. Look askance at ads touting a high return rate.

Some carriers may offer an upfront “bonus” to a rider to increase the amount of the Guaranteed Income Base instead of a higher roll-up rate. Recognize this for what it is – a marketing ploy. Look at the bottom line, not just the bonus.

Critical Comparison Point #4: Guaranteed Fees

Ah, fees. The bane of all investors’ happiness. Fees associated with annuities gets everyone’s knickers in a knot. The first thing to remember is there is not a financial product without fees. Sometimes the fees are “hidden” (built into the price or terms of the product), and sometimes they are assessed when the product is purchased or when the product is sold, but they are inevitable. So accept and investigate and know what you are getting into.

Fees are important!

Obviously, fees deducted from an investment lower the Return on Investment (ROI) and a lower ROI is not a desirable thing in an investment. (More discussion on the ROI of annuities will be found in Section C.)

The thing to remember, though, is an annuity is not a regular investment. It is an insurance policy. A variable annuity is nothing but a mutual fund investment wrapped in an insurance policy. A fixed annuity is an insurance product, not an investment. And the value of the insurance product is in the GUARANTEES it offers - not what it might do, not what it could do, and not what it has done in the past.

So for people wanting to buy an annuity for traditional transfer-of-risk reasons, fees are important to know not for the usual investment reasons but because fees impact the cash value of the policy. And in this case, the cash value is important because the cash value usually14 determines the death benefit15 payable to your beneficiaries when you pass away.

Fees are deducted from the cash value of an annuity. So high fees mean the cash value decreases at a faster rate. If the cash decreases at a faster rate, there is less left for your beneficiaries should you pass away while there is cash value left in the annuity.

Technically, if you don’t care about the death benefit of the annuity, you don’t have to care about the fees. Since you buy an annuity for the GUARANTEES and since the insurance carrier is going to continue to pay you during your lifetime (or spouse’s lifetime in the event of a joint annuity) even if the cash value goes to zero the fees don’t matter if you don’t care about the death benefit. But, of course, most people do care about the death benefit (to varying degrees). This is why the fees for annuities are important.

For people who are expecting to cash out of their annuity after the surrender charge period (if any) has passed (such as those who purchase variable annuities without a Guaranteed Income Base), the cash value will be of utmost importance and anything affecting cash value will impact how much cash they get to take home. In these instances, the fees are of even more importance than for traditional income-focused annuity purchasers and should be looked at under a microscope.

A variable annuity can have many different kinds of fees. There may be Mortality & Expense fees, Administrative fees, Contract Fees, Rider Fees, Distribution Charges, and mutual fund loads, among others. But there are no- and low-load variable annuities for sale that are worth checking out.

Fixed annuities have lower fees than variable annuities. A basic fixed annuity will have its fees built into the product (reflected in a lower interest rate, for example) and carry no additional fees. But many times optional extra benefits are available for an extra fee. The buyer must determine whether or not the benefit is worth the extra fee.

Use only fees characterized as guaranteed and make sure they are in writing. Be on the lookout for fees guaranteed only for a minimum amount of time. Make sure you know if there is a cap on how high the fees can go after the minimum amount of time has gone by (the cap should also be guaranteed). Additionally, make sure you know what the fees are based on. Many are based on cash value, but some are based on the Guaranteed Income Base (if the annuity has one). Dismiss immediately any salesperson who is anything less than completely transparent regarding fees, who doesn’t have a firm grasp on the fee details, or who makes statements like: “Well, yes, the fees can go up after 5 years, but don’t worry about that.....it’s highly unlikely the carrier will raise the fees.” Remember, it is the GUARANTEES that are of prime importance and the focus of your investigation/comparison.

NOTE: Sometimes in the minds of annuity purchasers commissions are lumped in with fees. They should not be. Commissions paid to annuity sales advisers will be discussed in Section C.

CASE HISTORY EXAMPLE – JIM AND JANE

Jim pored through much fine print before he finally stumbled upon the fees in the annuity contract he and Jane purchased. Hmm – looked like the income rider that guaranteed their income base was at 0.9% per year and was guaranteed for the life of the contract. And, the enhanced death benefit they also added cost 0.2% per year for a total of 1.1% per year. Was that good? He looked over the information he had found on Mike and Molly’s annuity – the fee for their income rider was 1% but only good for five years! It could be reset after five years – but there was no guarantee it would stay at 1%. It could go up to 2% per year – double what it was now. Jim was satisfied at least he didn’t have that uncertainty to think about.

CASE HISTORY EXAMPLE – MURIEL

Muriel sat quietly, somewhat shell-shocked as she looked at the fees associated with her variable annuity. First, there was a Mortality & Expense fee of 1.30% plus an administrative fee of .15% and a distribution charge (whatever that was) of .2%. Luckily there was no contract fee (waived because of the amount of money she invested). But the base contract charges totaled a whopping 1.65% Yikes! And that didn’t even count her rider fee of 1.25%. Then there were the subaccount charges of 1.06%. Altogether the fees totaled 3.96%! Her fees, over ten years, would come to at least $198K (if the value of her account did not drop below her initial purchase price of $500K) and might even be more (if the subaccounts did well). She tried to put things in perspective. After all, she had no spouse or children, and she had already set up and funded a trust for her cats should she pass away before them. Did it matter the cash would be eroded so seriously by fees? She determined to do more investigation.

CASE HISTORY EXAMPLE – BILL

In the annuity, Bill looked into there were no extraneous fees. All the fees were built into the 5.75% payout percentage the brokerage quoted him. He was glad a SPIA was so simple.

It is imperative you get a handle on the fees associated with any annuity you are considering. You need not concern yourself with fees built into the product as they will show up as either a lower Guaranteed Income Base or a lower Guaranteed Percentage Payout (or both). But you do need to concern yourself with added fees for any enhanced benefits you may decide you want.

Please note you may not know what all the fees will be before you decide which “extras” (or “enhanced” benefits) you want to add to the annuity. Those are discussed in the next step. So if you don’t already have an annuity in mind, read the next step, decide which benefits you cannot live without, and determine what those extra benefits will cost you. You can then plug that info in to compare two or more annuities intelligently.

WHY THIS INFO IS IMPORTANT TO YOU

These 4 Critical Comparison Points are the heart of any annuity. You must know them to accurately and knowledgeably compare 2 or more annuities. With this critical information, you can tell at a glance how one annuity stacks up against another and if further investigation into the annuity is warranted. This can save you time and frustration in your search for the best deal.

7 For an immediate annuity, this will always equal the initial premium paid.

8 A subaccount in a variable annuity is the account holding a mutual fund investment.

9 A rider is simply a contractual “extra” added to a basic insurance product.

10 Of course, if the value of her subaccounts were higher than the Guaranteed Income Base then this figure would be higher. But when doing a comparison, you need to work with only guaranteed amounts.

11 Of course, if the value of her subaccounts were higher than the Guaranteed Income Base then this figure would be higher. But when doing a comparison, you need to work with only guaranteed amounts.

12 The word return is in quotes because technically the increase in the Guaranteed Income Base is not considered the return on investment (ROI). But some salespeople either don’t understand this or actively ignore this fact. As a licensed insurance agent, I occasionally get unsolicited emails from broker/dealers encouraging me to show my clients how I can “double their money.” So the ignorance (or malfeasance) is widespread.

13 More on these tactics in Section C.

14 I say “usually” because it is possible to purchase an enhanced death benefit not based on the cash value. This is discussed further in Step 3 of this section: Fine Tuning Additional Considerations.

15 If indeed a death benefit