I push back hard against Jeske’s narrow acceptance of the SPIA, and I do so even while recognizing that a lot of thoughtful retirement geeks, like Rob Berger, share his view. I bristle at this view because I own and understand my FIA with income rider. It actually competes well with the SPIA model.
The objection to an FIA with income rider rests on several observations, including the idea that they are more complex than SPIAs, they have fees that SPIAs don’t have, and the index linked growth is stunted by features like caps, spreads and participation rates.
Another downside often cited is the phantom bonuses and rollup rates used to aggressively market the annuity as though it magically grows money. And of course there is no inflation adjustment. Also, there are surrender fees that apply if you suddenly decide you want to pull out of the contract within the first ten years.
These are technically correct observations, but substantively none of these things diminishes the more important concept that the income rider part of the contract neutralizes all these concerns.
Yes it’s more complex. No argument there. Fees and return-throttling mechanisms are present, for sure. But when I signed the contract, I evaluated the only contract term that would move the needle for me, i.e. is the guaranteed lifetime income stream going to make this contract worth my time and money even after I consider the fees?
In the case of this contract, the answer was easy. The payout rate is going to be 8% of the original principal, every year, until I die. When I calculated that the payout, combined with social security, would cover my fixed expenses, I was ready to sign the contract. The fees will be assessed against my principal during the decade or so of principal payback embedded in the income stream. Those fees will not impact the 8% payout rate by a single penny, as that rate is guaranteed.
The muted index linked growth is just background noise that I can ignore. I’ll never enjoy the benefit of that growth, as I have calculated that I will never have to access the principal or its growth during my lifetime. The only access I care about is to that 8% annual income stream.
The phantom bonus and rollup rate in my contract do have a net positive impact. They are responsible for the 8% level of payout, as the payout rate is calculated using the role up rate against the principal amount plus the bonus. In absolute terms, that adds up to 8% against my principal, so I’m good with that.
The lack of inflation adjustment is a real issue. But it’s an issue that’s equally present in any SPIA contract. More importantly, the calculation I made looks at the practical impact of the income stream even after accounting for inflation erosion.
Out of the gate, the annuity income plus social security covers my fixed expenses, resulting in massive pressure relief off my IRA, which I’ll rely on only for discretionary spending, at a withdrawal rate that can go as high as 4% if I’m living big, but can easily shrink to 1% or 2% if the market is having a tantrum.
As the years pass, the lack of pressure on the IRA will slowly give way to the falling spending power of the annuity income stream, but by the time I feel that affect on a practical level, the IRA will have experienced solid growth that will more than offset the shrinking spending power of the annuity income. So I’m good with that.
The surrender fees are not a deterrent. Since I’m careful to only silo a reasonable portion of my net worth to the annuity, there is no spending shock in the future that will be large enough for me to abandon the lifetime income stream and reclaim whatever remains of my principal. That box is therefore checked, no problem. If anything the limited access to principal actually is an advantage over the SPIA, which requires you to permanently wave goodbye to your principal on day one of the contract.
As with any financial decision, buying a FIA with income rider or a SPIA demands that you identify the tradeoffs involved and decide whether the juice is worth the squeeze. In my case it is.
Finally the lingering question might be why select an FIA with income rider over its simpler cousin, the SPIA. In my age range, and with my ability to defer the income for a couple of years, the payout rate is simply higher than the rate that SPIAs are currently offering. So the choice is easy.
If I were older than 70, it happens that SPIAs start to pay much higher rates because the annuitant will die earlier and the insurance company can shoulder the risk of higher payouts. If I were that old, I’d choose a higher paying SPIA without batting an eye.
