Understanding Annuity Payout Options for Retirement Investors

Before retiring in 2014, Ellen Donahue, a former registered nurse, allocated $180,000 from her Individual Retirement Account (IRA) into an annuity to secure future income. Now 75, Ellen and her husband, Joe, 73, find their financial needs comfortably met through Social Security, Joe's military pension, and required minimum distributions from various accounts. However, Ellen has concerns about her investment: the annuity's decreasing value and her uncertainty about withdrawal options. "I don't know how we let someone talk us into these products when we didn't really understand them," she mentioned to Jean Chatzky, a well-known financial expert.

Ellen's investment was in a fixed index annuity (FIA) featuring a guaranteed income rider. The annuity's value was linked to the growth of the S&P 500, providing gains without exposure to market losses. The income rider, added at a cost, promised a set annual payment regardless of the annuity's performance and currently costs about $4,000 annually.

Ellen has three withdrawal options. She can activate the income rider for lifetime income, withdraw varying amounts as needed, or liquidate the annuity and reinvest within her IRA. Since turning 70½, she has used withdrawals from her FIA to meet her required minimum distributions. However, these withdrawals combined with the fees have diminished the annuity's value.

Scott Witt, a fee-only insurance advisor, assessed Ellen's situation by comparing the annuity's account value against the income rider's benefit base. The account, or cash value, is the amount she could withdraw minus any charges and fees, and was currently $141,000. The benefit base, a figure used for calculating the guaranteed income, was significantly higher at $300,000. This disparity suggested that utilizing the rider was the most beneficial option, according to Witt.

Witt determined that the income rider would provide Ellen with an annual income of $19,500 for life. If she chose to cash out the annuity and purchase another on the current market with the same $141,000, she would receive approximately $13,000 annually. He also calculated that to replicate the income provided by the rider, her investments would need to yield an unrealistic 15% annual return if she lived to 95, a plausible scenario given current statistics for her age.

While suggesting activating the income rider, Witt pointed out that if Ellen had poor health, his advice might differ. If the benefit base does not substantially surpass the account value, withdrawing the full cash value could be more appealing.

Ultimately, Ellen, although initially hesitant, decided to turn on the income rider. "I assumed it would be better to let it sit there," she reflected. While the cash value might decline annually, it offers a steady income throughout her lifetime, with any remaining value passing to her heirs. With the income, Ellen plans to invest further and possibly support her children or visit them more often.