Michael Lewis, author of “Moneyball,” pointed out at a recent industry conference that “experts make mistakes, and analyzing data can help prevent gut calls that become bad decisions.” The Oakland A’s dissected statistics and analyzed data to identify undervalued players. The process became known as the “Moneyball” method and is now used in all major sports. This same process of identifying and exploiting inefficiencies can be applied to any problem, such as increasing retirement income. The rewards for continuing to defer an income rider payout option is counter-intuitive to the average investor who is used to being rewarded for allowing the magic of compound interest to work over time. It doesn’t help when most of the brochures focus on the compounding of the income account value.

Imagine if you could engineer a $30,000 to $150,000 increase in your client’s total guaranteed lifetime income benefit payments (GLIB rider) and prove it mathematically. The following example will show you how to increase potential lifetime guaranteed income by calculating the Optimum Starting Point to turn on optional income rider payments.

Many advisors know how to sell income benefits riders, but few have taken the time to determine how to maximize the payout based on their client’s individual objectives. This article is going to teach you how to identify the power curve, where the client would receive the maximum payout based on their objective. You will also learn how to quickly identify inefficiencies to their maximum benefit.

We will start from the premise that your client already owns an annuity with an income rider, and you want to help them generate the largest possible return for the additional charges incurred. I am also going to assume account value is not a primary concern. We will determine the Optimum Starting Point of the income rider to increase the likelihood that your client receives the largest total payout and rate of return by calculating the best time to activate the rider for his or her specific contract and desired end point.

On the surface, Guaranteed Lifetime Income Riders are designed to provide security from running out of money, in exchange for an additional expense called a rider charge. There is, however, no such thing as a free lunch, and you need to very carefully identify the quid-pro-quo for your clients. These riders are designed to create an actuarial profit for the carriers that make them available on their various annuity contracts. It is best if you think of an income rider as an option, but not an obligation to start a minimum withdrawal amount at some point in the future. The brochure may discuss various guaranteed interest “roll-up” rates for the income account, which is called a secondary account feature. This secondary account is only used for calculating income payments and is not to be confused with the accumulation value and can not be removed as a lump sum–so you and your clients need to understand the math. 

Once a client owns an annuity with an Income Rider, they basically have three options relative to the rider itself:

1: Turn the payments on immediately.
2: Turn the payments on later (defer).  
3: Never turn the payments on (ignore or cancel).

Many agents automatically advise clients to defer as long as possible before turning on an income rider, because the income account is growing at a certain rate of return (such as 6, 7 or 8 percent). This is an overgeneralization that could cost your client tens of thousands of dollars, as in our examples below.

The brochure language is designed to get the client excited about certain aspects of an annuity that may or may not create value for themselves (it is your job to figure this out). As an example, a certain annuity or rider may double the income account value after a 10 year period, but the actual value/return enjoyed by your client is not determined solely by the size of the income account.

Taken individually, income account bonuses, guaranteed roll-up rates up rates, and income account size is meaningless. The carrier could provide 10 percent roll-up and then recapture that “marketing calculation” with a reduced 4.0% payout factor. The only way to cut through the fog is to focus on the factors that are important to calculating the internal rate of return probabilistically for your client.

If we want to view this as a formula, we know the current account value and age of the client. We can calculate the income payouts from the statement or contract for various income start ages. We can also use probabilities and health history to select a likely ending point for the income. As long as we use the same calculation summary age for the various income rider start ages, we can determine if there is value to be gained by using a different starting age. Let the client determine what survival probability with which they feel most comfortable.

The factors that determine the ultimate value received by your client are:

1: Current Account Value
2: Age of Client when they Start Income
3: Amount of Income Payment
4: Rider Charges
5: How Long the Client Lives and Receives Income
6: Ending Account Value (we are using zero growth for this article because we are only evaluating the income rider portion)

Reasons to Turn It On Now
Since one of the “known knowns” is mortality, I always start with the hypothesis that the earlier the client turns on the income rider, the better the odds that they are going to live long enough to receive an amount greater than their principal:

  • If it is a variable annuity and the account is substantially underwater. I have seen IRR’s as high as 9% through age 85 because the account value was substantially underwater.
  • If the client is older than 70, has a cap and is paying a fee.
  • The rollup period is over.
  • The client needs the income now.

Reason to Turn It On Later (Defer) 
The next step is to determine if there are any significant changes in the rollup values. This is done in order to evaluate whether the payout of deferring is real or imagined when juxtaposed against probable life expectancy and calculation age. A common error is that many clients grew up with a “saver’s mentality,” and they feel that the longer they let the income rider compound, the better. The trade-off is that, for every year you increase the size of the payment because of roll-up and payout factors, you are also one year closer to death. By calculating the IRR at the client’s agreed upon life expectancy age, you can quickly determine the Optimal Starting Point for your client’s needs.

To determine the IRR (Internal Rate of Return) at a chosen calculation age, we will need the current account value (not income account), the current age of the client, and the guaranteed income payout for the ages we want to test. So using a sample set of client data:

Current Age: 65 (Male) 
Current Account Value: $200,000
Accumulation Growth Assumption: 0%
Rider Charge: 1%
Calculation Age: 85

We determined the payout factors and income below–for each starting age of 65 through 80–in order to determine the sweet spot. The object is to provide the largest possible return through age 85 based on our calculations. The table below was created using payouts calculated at siaincome.com and using annuitycheck.com for IRR calculations. Payout factors will vary widely based on carrier, the age of the client, desired calculation age, and charges.

Total Payouts and IRR through Age 85
Start Age Payout Amount Payout Years Total Value (85) IRR
65 $10,584 20 $211,680 0.61%
66 $11,502 19 $218,538 0.90%
67 $12,495 18 $224,910 1.14%
68 $13,568 17 $230,656 1.32%
69 $14,727 16 $235,632 1.46%
70 $15,981 15 $239,715 1.54%
71 $17,355 14 $242,970 1.59%
72 $18,797 13 $244,361 1.57%
73 $20,376 12 $244,512 1.51%
74 $22,081 11 $242,891 1.40%
75 $23,922 10 $239,220 1.25%
76 $24,328 9 $218,952 0.61%
77 $24,733 8 $197,864 -0.07%
78 $25,139 7 $175,973 -0.80%
79 $25,544 6 $168,857 -1.0%
80 $25,950 5 $167,422 -1.0%



“Income rider deferral is your friend until the end when it bends.”

As long as there are no other factors in the decision, turning on income at age 71 would create the highest IRR in this particular case.  If there were a need for income prior to this date, the client could simply take withdrawals. The total payout increase between starting ages of 65 and 71 is $31,290.

Now we will look at the same calculations using age 95 as the calculation age.


Current Age: 65 (Male)

Current Account Value: $200,000
Accumulation Growth Assumption: 0%
Rider Charge: 1%
Calculation Age: 95

Total Payouts and IRR through Age 95
Start Age Payout Amount Payout Years Total Value (95) IRR
65 $10,584 30 $317,520 3.65%
66 $11,502 29 $333,558 3.80%
67 $12,495 28 $349,860 4.01%
68 $13,568 27 $366,226 4.18%
69 $14,727 26 $382,902 4.33%
70 $15,981 25 $399,525 4.45%
71 $17,355 24 $416,520 4.56%
72 $18,797 23 $432,331 4.64%
73 $20,376 22 $448,272 4.70%
74 $22,081 21 $463,701 4.74%
75 $23,922 20 $478.440 4.77%
76 $24,328 19 $462,232 4.42%
77 $24,733 18 $445,194 4.09%
78 $25,139 17 $427,363 3.76%
79 $25,544 16 $408,704 3.44%
80 $25,950 15 $389,250 3.12%



In the example, using age 95 as our target age, turning on income at age 75 would create the highest IRR.  If there were a need for income prior to this date, the client could simply take withdrawals. The total payout increase between starting at 70 vs 75 is an additional $78,915. The increase in payouts is hypothetical because mortality is never guaranteed, and you can never calculate the final IRR going forward (such as with a fixed interest rate)–only looking back from the final point. The purpose of the process is to determine Optimum Starting Point based on the clients perceived ending point, not yours.

Turn It Off
In many cases, the client won’t want to turn the rider on at all. The following situations may benefit more from systematic withdrawal strategy:

  • The client is beyond age 75. It is statistically difficult to benefit from an income rider that has not been activated unless the client has a reason to believe that they are going to live substantially beyond normal life expectancy or have a very low accumulation value compared to the income payouts.
  • The client has Substandard health concerns.
  • His or her income needs are met through other sources (such as pensions).
  • The client’s objective is leaving maximum for heirs.
  • The client is wealthy and wants to maximize growth.

Income riders are a great invention, but there are significant pitfalls if you and your client don’t understand how to maximize the payouts. There are definite trade-offs that you need to be able to calculate for your clients if you wish to be operating in a true fiduciary capacity.

 While many of the annuities with income riders also have a growth component, we left those out of this exercise because we are focusing on evaluating the income rider Internal Rate of Return, independent of the cash values.

 

Let me know what you think about the above results. Can advisors create a substantial edge by using this type of Moneyball method?