If you are like most people, you might see that your company offers you some pretty good benefits.  One of those benefits just might be group disability insurance.  You say ‘great’ and sign right up.  The money comes right out of your paycheck and you think ‘at least if something happens I am protected’.  That’s perfectly normal.  Just like any healthy well adjusted person you think two things: 1. I’m never going to need it, and 2. I’m covered just in case.

What most people don’t realize is what ‘covered’ means.  If you are really on your group disability insurance the key is that you don’t control the coverage that you have, your employer does.  Whether it is good, great or horrible coverage is up to you to figure out.  Last time we looked at 7 Ways Your Group Disability Insurance Will Fail.  Today, we’ve got a few more things to add to the list.

1. You could loose your job. Your group disability insurance policy is dependent on you having a job.  Since it is offered through your employer, if you loose your employment you loose your policy.  The next job you get may or may not offer the same benefits.  Also, if they don’t, you maybe paying more for your individual disability insurance policy because your not getting any young and your health probably isn’t getting a whole lot better.
2. You could loose your policy. Your employer controls your policy.  They decide how good of coverage the group disability insurance policy will offer.  Just because you have a good policy today doesn’t mean you will tomorrow.  When times are tough your employer could easily decide to cut coverage to save money.  Or worse yet, they could drop it all together.
3. Expect the premiums to increase. It’s a group benefit.  Just like your health insurance, every time your plan is up for renewal you are most likely going to see a premium increase.  Unlike, health insurance, some of the larger group disability insurance policies might lock in premiums for 2 or 3 years.  However, they are still going to increase soon whereas an individual disability insurance policy the premiums are locked in as long as the policy stays in force.
4. It’s an ERISA plan.  Group disability insurance plans fall under a federal statute called the Employees Retirement Income Securities Act (ERISA).  The biggest downfall for this in regards to disability insurance is appeals.  If you were to get denied a claim through a group policy there are a lot stricter set of rules to follow.  You’re options are also a lot more limited.  For instance, through ERISA you are not entitled to a jury trial and you will almost never receive any type of attorney’s fees or punitive damages.
5. It’s limited to your employment income. Do you have any income that you receive outside of work?  When I say that I mean earned income.  Any unearned income will offset you disability benefit in an individual policy.  However, any earned income outside of your employer will not be covered.  Maybe you have a side job that you receive income from or a second job, these are not covered.

It’s not unusual to find out that the coverage you thought was great is grossly inadequate.  Do you, and more importantly, your loved ones a favor, review your coverage.  Talk to a qualified financial professional when you don’t understand what they are telling you come ask me.  An insurance assessment is a great way to learn about what you do have and make better decisions with your money.  Most people will supplement their group disability coverage with an individual disability insurance policy to fill the gaps and/or shortfalls.

Related posts:

1. 7 Ways Your Group Disability Will Fail
2. Pricing Your Disability Insurance
3. 7 Disability Insurance Add-on Features

Last week we started by looking at some sweet spots for your disability insurance policies.  This week we are going to jump right into looking at some add-on features that you need to know about when evaluating your own disability insurance policy or shopping for a new and/or better policy.

1.  Catastrophic Rider

I’m starting with the catastrophic rider because it is one of the more inexpensive riders to add on to your disability insurance policy that can provide a huge benefit.  The catastrophic rider pays additional benefits for certain severe disabilities.  Severe disability is usually defined as presumptive disability or total disability.  The benefits of this rider is that you will receive a higher disability payout usually about 100% of your pre-disability income.

2.  Cost of Living Adjustment Rider

This is usually referred to as the COLA rider.  One of the biggest eroding factors of your wealth is inflation.  A great way to offset, or fight back, is adding a cost of living adjustment rider.  This rider can insure that your monthly benefit will keep pace with inflation.  Most of these riders have a 3% adjustment built in.  Make sure it is a compounded 3% and not a simple 3%.

I’ve also seen this adjustment work in a few different ways.  For some policies it only goes in affect when you are out on a claim.  In this case, you make a claim and your benefits will begin to increase 3% per year going forward.  I’ve also see this adjustment be made to your benefits regardless of any claims.  If your cost of living adjustment rider only kicks in when you make a claim, you are usually offered an additional rider as well.  This additional rider would be a benefits increase rider that would adjust your benefit amount before any claims where made and will usually result in your premium increasing slightly each year.

3.  Future Insurability Rider

This rider is sometimes referred to as the future increase option rider or FIO rider.  This rider allows you to purchase additional coverage without providing further proof of medical insurability.  You are, however, usually required to go through financial underwriting to make sure you qualify for the increased coverage.  This is a great benefit if you plan on having substantial raises or job opportunities in your future.  For example, if your goal is to rise through the rankings of your company, chances are each rise in rank will result in a nice bump in salary.  To be adequately covered you need your disability insurance policy to keep pace with your salary.  This is how you can lock in the ability to increase your coverage regardless of your health.

4.  Social Security Insurance Rider

This is an opportunity to save some money on your disability insurance.  What this rider does is offset the insurance company’s risk with any social security benefits you may receive.  It decreases the price of your insurance by providing a lower base benefit.  You would then add on the social security insurance rider and apply for social security disability benefit when something happens.  If your social security benefit kicks in then you would receive your base benefit from your individual disability insurance policy.  However, if social security denies you (as so often happens the first few times of applying) and you are considered disability under your individual disability insurance policy, this rider would step up to cover your social security disability benefit until when and if you ever qualify through social security.

5.  Residual Disability Benefit Rider

This rider is sometimes referred to as the partial disability benefits rider and provides a disability benefit if, when the insured is able to return to work and as a result of the disability, continues to suffer a loss in income.  The income loss is usually set to 20% or greater but I have see some as low as 15%.  For most people that become disabled there will come a time when your doctor says that it’s okay for your to return to work.  Unfortunately, you might not be able to jump right back into working full-time.  This rider allows you to ease your way back to work while picking up the loss of income from doing so.

6.  Own Occupation Rider

I only know of one company that offers disability insurance policies with built-in own occupation.  For all other disability insurance companies this is an add on feature.  The key to the own occupation rider is that even if you are able to return to work, if you are unable to perform the main duties and requirements of your previous occupation, you will continue to receive benefits from your disability insurance policy.  These benefits are regardless of whether you are working in another occupation or not.

7.  Retirement Protection Rider

This is one of the newer riders that I have seen on disability insurance policies.  In fact, this is usually offered as a stand alone policy as well.  Most people don’t realize that when you are unable to work, you no longer are allowed to contribute to a retirement plan.  When you become disabled you can’t continue to contribute to your retirement and the money you were previously contributing is not protected.   The retirement protection rider is designed to help ensure retirement funding can continue even if you are disabled.  You can usually cover up to 100% of retirement contributions, including employer-matching funds.  The way the retirement protection rider works is that benefits are paid into an irrevocable trust for your benefit and proceeds are distributed when you reach age 65.

Final Words

I’ve done my best to explain the main disability insurance riders or add-on features that most insurance companies make available.  These riders, as well as whether they are offered or not, can vary greatly from insurance company to insurance company and/or from disability insurance policy to disability insurance policy.  If you have any questions on your specific disability insurance policy then ask your financial professional.  If you don’t like his/her answer, don’t have a financial professional or are looking to obtain disability insurance feel free to contact me and/or look into an insurance assessment.

Related posts:

1. Pricing Your Disability Insurance
2. 5 More Ways Group Disability Insurance Disappoints
3. What Every Life Insurance Policy Shouldn’t Be Without

Has anyone ever asked you what your definition of financial planning is?

There is no right or wrong answer.  In fact, I think I’ll pose this question on FiLife.com and see what we get.  Feel free to share your definition or your thoughts in the comments below as well.  In the meantime, I’ll share my definition with you.

For me, financial planning is maximizing choice and minimizing risk  and loss.

Maximizing Choice – the fun things in life

• Retirement
• Education
• Vacation
• Other funding goals (new home, second house, new car, etc.)

Minimizing Risk & Loss – the things people don’t like to talk about and we can’t control

• Taxes
• Inflation
• the Economy
• Death
• Disability
• Long Term Illness

What do you think of my definition?  How does it vary from your own?

Related posts:

1. Carnival of Financial Planning #112
2. Your Ideal Financial Planner
3. RMA: Income Planning Program

Price is only an issue in the absence of value.  The problem with disability insurance is determining value.  To understand this we first need to look at how disability insurance policies are priced.  We want to make sure we are getting the most bang for the buck and see if we can find some sweet spots from a pricing standpoint.

Occupation

The basis of all disability policies is to protect your income if/when you are unable to work.  Your occupation is the core measurement of risk from an insurance company’s point of view.  Occupation classes usually use a scale from from 5 to 1, 5 being the less riskier jobs to 1 being more risky.  Then they will sometimes add on an A and B for even riskier hands on occupation classes.  Obviously, the lower risk occupations become more cost efficient to protect.  For instance an office job is a lot safer from an insurance companies prospective than a job which requires substantial field work.  An office job might be a 4 or a 5 occ class while field work might be a 1 or a 2 occ class.  This makes the duties of your occupation even more important than the title itself.

An example of this is an engineer.  There are various different types of engineers that range from doing design from the comfort of their office to traveling and on-site field work.  I’ve seen engineer occupation classes range from a 2 all the way up to a 5 occ class.  This can really change things from a pricing standpoint as well as what companies will be most competitive for this particular person’s situation.

Income Protection

The first real decision that someone looking for disability has to make is how much of their income are they going to protect.  Under most circumstances the maximum coverage you can obtain for income protection is protecting 60-70% of your income.  This is an area where most people’s group disability fails (if you even have group coverage).  When your group disability falls short, the best thing you can do is put and individual supplemental disability insurance policy in place to help protect your short fall.  (Make sure not to mistake this for Aflac which is supplemental insurance and something totally different)

Why wouldn’t you want to cover as much of your income as possible?  A disability insurance assessment is a great way to determine whether you are or not.

Elimination Period

The next decision you’ll need to make when looking for disability insurance is when it will kick in.  For those more familiar with health insurance, which refers to it as a deductible, this is different because it doesn’t measure the money you will have to front but instead measures the time for which you have been disabled.

The most common elimination periods are measured in days: 0, 30, 60, 90, 180 and 360.  The sweet spot for most disability insurance polices is 90 days.  The reason for this is that there is usually a decent increase in premium to shorten your elimination period less than 90 days and little savings by increasing your elimination period beyond 90 days.  The best place to start here is 90 days.

Coverage Period

Coverage period is the length of time for which a disability insurance policy will pay benefits.  The most common coverage periods use to be: 2 years, 5 years, 10 years and to age 65.  Today there are more policies that have added: to age 67, to age 70 and even lifetime graded benefits.  The reality is that people are working longer today.

The sweet spot for coverage period is usually to age 65 or to age 67 if you are offered it.  I say if because some higher risk occupation classes have limited coverage periods.  If you are comparing policies age 65 is your best place to start.

Riders

Riders are add-ons to your disability policy that provide extra benefits for you as a policy holder.  However, they are not free.  Stay tuned for next week when I’ll cover the 7 disability insurance riders you need to know about.

Related posts:

1. 7 Disability Insurance Add-on Features
2. 7 Ways Your Group Disability Will Fail
3. 5 More Ways Group Disability Insurance Disappoints

I don’t know about you but when I decide to go out to eat, where I go depends on what mood I’m in.

• Burger – I’m probably heading to a bar or pub.
• Fish - I’m going to a seafood place
• Steak - Has to be a steakhouse they almost always have the best cuts of beef.
• Pasta - Italian, what can I say?
• Sushi - You have to go to a specialty place for this.  I don’t mess around with raw fish.

What I do know is that if I want Chinese food I’m not going to the Italian restaurant and if I want sushi, I’m definitely not going to a pub.

Sometimes when I’m going out for eat I can’t decide what I’m in the mood for.  I have a couple of restaurants that I frequent just for these occasions.  I know that I’ll get some good food at these place but they don’t specialize in a certain type of food.  These restaurants won’t necessarily satisfy a craving I have but they will fill me up.  By understanding this it really saves me from being disappointed.

Are you a fan of buffets?

What I notice about buffets is that I’m definitely going to get full but I’m really not going to have any really good food.  It depends on what you value, quality or quantity.  Buffets help you find instant gratification but they don’t give you any real quality of food.

Your Financial Planner

Is he your financial buffet?  From my experience, most financial planners specialize in certain areas.

• Investments - wealth managers that charge a percentage of assets under management
• Life, disability & LTC insurance – insurance specialists that are paid on commissions
• Auto, homeowners & liability insurance – property and casualty firms that are paid on commissions
• Holistic plan – financial planner that looks at your full financial picture, could be compensated a few different ways
• Taxes – an accountant that is usually paid by the hour or a flat fee
• Wills & Trusts – an attorney that is usually paid by the hour or a flat fee

Just as there are more types of food than I listed there are a lot more financial areas that you have, and will continue to have to, make decisions about.  Unfortunately, the easiest solution (a buffet) isn’t always the best.  If you are looking to have quality service and quality advice you just might need to deal with a few different specialists in the areas of your finances that need the most attention.

Your financial planner might be a buffet. They have a ton to offer but none of it is really any good.  They will fill you up with a bunch of crap though.  Is that what you want?

Related posts:

1. Your Ideal Financial Planner

Most people don’t even think about disability.  It’s sort of the ninja of personal finance.  It silently hurts you.  The reason I say this is because there is no announcement in the newspaper and there are no big events held.  Something bad happens and you end up in near seclusion as you try to recover.  Usually the only people that are around to help and support you are your family and friends.  Unless you are one of those people you never realize what someone has to deal with when they become disabled.

Maybe you are one of the lucky one’s that has group disability coverage through work.  You really, truly want to believe that your coverage will be there to help you if something were to happen.  Well here’s 7 ways that group disability coverage will fail you.

1. It covers 60% of your income. Most group disability insurance covers up to 60% of your income.  Can you live with that big of a pay cut?  Don’t forget to add on the extra medical bills from the accident that caused the disability.  Then there are the medical bills from the rehabilitation.  Well we can ignore those for now.  Make a list of your five biggest bills (mortgage, car payment, taxes, etc.).  Now which two aren’t you going to pay?
2. You’re employer is nice enough to pay for it. Isn’t that nice of your employer to pay for your group disability insurance?  I would think so too at first.  From an IRS standpoint though, if your employer pays for the coverage that means you don’t pay taxes on that money.  Now if you were to become disabled, since there were not taxes paid yet, the benefits are now taxable.  This means that if you are in a 15% effective tax rate, then your 60% coverage just got cut down to about 50%.
3. You make bonuses and/or commissions. There are a lot of people out there who have a large part of their income tied to bonuses and/or commissions.  Did you know that most group disability insurance doesn’t cover these at all?  Usually they only cover base salary.  This means that if you have a $100,000 base salary plus an extra $50,000 through bonuses and/or commissions, then when you factor in #1 & #2 above you are now down to about 33% coverage.  The pay cut just keeps getting bigger.
4. There is also a cap. Most group coverage will cap your monthly coverage amount.  The most common cap is between $5,000-$6,000 per month.  To give you an idea, each $1,000 of month coverage, covers $20,000 of salary at 60%.  So a $5,000 cap will cover the first $100,000 and a $6,000 cap will cover the first $120,000.  If you make more than that, you are taking an even bigger pay cut.
5. There is a social security offset. Most group disability insurance will offset your benefit by the amount you receive from social security.  If you’ve been reading this thinking that you’ll have some extra money on top of your disability benefit, don’t count on it.  Some companies won’t even pay you the social security portion until your coverage has been denied by social security (which will most likely happen when you apply anyways).
6. You can go work somewhere else. With disability insurance there is a feature called own-occupation.  This means that you are unable to perform the duties of your specific occupation even if you are able to work in an other occupation.  Good group disability coverage will cover your own-occupation for a period of 2 years after that if you can work anywhere (yes, even McDonald’s) then you receive no more benefits.  Notice I said ‘good’ coverage, a lot of policies don’t even have the own-occupation benefit.
7. You can’t contribute to your 401k when you aren’t working. No one ever thinks of this.  If you are not working you cannot contribute to your company 401k.  I have yet to see any type of group coverage that will account or help with this in any way.  Most individual disability insurance policies will have a rider or stand alone feature that will continue to contribute to your retirement for you if you were to become disable (yes, this costs extra).

If you ever get a financial plan done it should include an analysis of your disability coverage.  A lot of times and individual disability insurance policy is needed to supplement your group coverage in order to provide adequate protection for you and your loves ones.  If you are unsure about your coverage you should consult a financial professional or get an insurance assessment.

Related posts:

1. 5 More Ways Group Disability Insurance Disappoints
2. Pricing Your Disability Insurance
3. 7 Disability Insurance Add-on Features

I am a contributor at FiLife.com.  For anyone who has never been there, I highly suggest you check out the site.  There is a lot of great information there.  It also has the best Question & Answer section I’ve seen in regards to financial information.  Here’s where my experiment comes in, I asked the following question:

What is the single, most devastating thing that can completely destroy your retirement and all the planning you’ve put into it?

This question received 14 comments by 9 different people.  I first want to thank everyone for their contributions.  I will do so by doing my best to link to their sites in the following list.  Without further ado…

The Top 10 Most Devastating Things that Destroy Your Retirement

10.  Liability Exposure from Mark Kantrowitz – I feel like this is something that is easy to protect yet most people don’t understand it so they do nothing, until it’s too late.

9.  Divorce from Kevin Brosious – I’ve been through this so it wasn’t going to be too high on my list.  Definitely recoverable.

8.  Company Stock from Kees DeWit – To me you are investing in something you know more about or might be more comfortable with.  This isn’t a horrible thing but you do need to be diversified in other investments as well.

7.  Lack of Diversification from Mark Kantrovitz – Going hand-in-hand with #8.  Overexposure to one area can cause a lot of pain.

6.  Unemployment from Morris Armstrong – Being out of work for an extended period of time can cause you to eat into or eliminate everything you have worked for and everything you were hoping for in regards to retirement.

5.  Inability to Live Within Your Means from Elanor Blayney – It does matter how much money you make or what your investments look like.  If you keep building debt then you are either destroying your retirement or you just might never have one.

4.  Chronic Medical Issue from Fern Alix LaRocca – With the rising cost of health treatments and how increasingly difficult it is to have adequate (not even good) insurance coverage, this not only affects you during the illness but long after as well.

3.  Total Disability from Fischer Financial – Unfortunately, you don’t recover from this.  Once you stop working you can’t even contribute to your retirement plan so no need to worry some earlier numbers.

2.  Death from Morris Armstrong – No one can ever truly prepare for this.  Nothing is worse for your retirement then never even getting there.  Hopefully those that depend on you are protected.

1.  Lack of [Proper] Preparation from Elanor Blayney – As I look back at this list, there are a lot of things that can be negated to some extend.  The only way to do that is to plan and prepare.

So there’s my list, what do you think?  I struggled with a few of these and there are definitely arguments to move a few things around.  I’ve love to hear your responses…that’s what the comments are for.  In the end I had to add in the word ‘proper’ to really finish the list off.  Unfortunately, so many people hire a so-called financial planner but they don’t get proper planner.  I see planners all the time gloss over a lot of the things I just listed.  Maybe this will work as a guideline to help you make sure you are working with a good planner.  Did he/she cover everyone of these areas?

Related posts:

1. 401k, God or Devil?
2. Your 403b Could Be Detrimental To Your Pension
3. Retirement Denial?

When you look around at people’s lives there seems to be 2 things that show up in most people’s financial worlds.  If they aren’t there directly it’s 2 things that the people are working towards.  Any guesses?  They are both marketed to widely by the largest financial companies in the US.  Give up?  The 2 things are your 401k and your house.

Chances are you read everywhere how you should be contributing as much as possible to your 401k.  Most of these messages are initiated by two groups, the financial companies and the government.  Then you add in that your whole life you are told that you need to own your own house.  It is instilled in us at such a young age that most people never even question it.  They work to get a mortgage, in order to get their own house.  I have to ask, is this a good thing?

As I was reading The Best Way to Avoid the Worst Financial Problems from @wisebread it reminded me of the 6 principles of the Evolution of Wealth.  Honestly, I have put aside the principles that I originally wrote up.  Why?  Well I really don’t have a reason, basically because life happens and I’ve tried to let this blog go where it goes.  It was the following paragraph in that post that jumped out at me:

I can give it to you in once sentence: Keep the cost structure of your household flexible. That is, arrange your life so that you can react to a fall in your income by reducing your expenses.

This screamed principle #1: the power of LUC.  Did I forget the k?  No.  LUC stands for liquidity, use and control.  These are the main features of flexibility.  Now let’s look at the 2 most popular financial tools that play a major role in everyone’s financial world.

How does a 401k provide flexibility?  Does it provide liquidity, use and control?

1. Liquidity – Fail!  When flexibility is most important, it is difficult to access the money that you put into a 401k.  There are penalties and fees associated with the access as well as probably having to jump through a few hoops.
2. Use – There’s only 1.  It’s saving for retirement.  The money is in your account doing 1 thing, or should I say hopefully doing 1 thing.  People loose track of the main purpose or maybe the only purpose of a 401k.  Saving for retirement.
3. Control – Do you even have any?  The government dictates when and how you can access the money.  The employer or plan administrator dictates the rules surrounding access and investments.  Might you just be a pawn?

How about your house?  Any flexibility there?

1. Liquidity - Is it easy to get money out of your house?  I guess you might be able to convince me if and only if you have a large equity line of credit established.  Oh, what did you say?  Banks are taking those away?  Guess this is a FAIL too.
2. Use - You could make an argument for some use here.  It provides shelter.  It provides some tax benefits.  It might provide some rate or return (emphasis on maybe).
3. Control - This should be a good one…who controls your house?  Let’s see, you need to ask permission and prove that you should be able to pay just to get a mortgage.  Then if something bad happens, just when you need there help the most, the bank says ‘NO’.  Doesn’t sound like much control to me.

Might the 2 most widely used financial tools also be the worst based on Principle #1 and wisebread.com‘s “Avoiding the Worst Financial Problems”?

Related posts:

1. Max Out Your 401k Math
2. 401k, God or Devil?
3. 6 Reasons Not to Max Your 401k

Have you ever asked your financial adviser what he/she does? What was the response?  Was it a long list of things?  Did it make any sense?  I work with financial advisers, I network with them, I meet them all the time, they are everywhere.  The second biggest turnoff when talking with these people is when they tell me they do everything.  Maybe it’s just me but I constantly struggle with this.  Or maybe it’s my background.

When I started in the financial industry I was pretty fresh out of college.  I was deciding between working for a big wirehouse and a smaller boutique firm.  I chose the smaller one pretty much because I didn’t want to work under someone else for a few years.  I wanted to build my own business.

The funniest thing in the industry is training.  I’m convinced the training is based on the business model that there will be huge turnover.  Depending on where you look most statistics say something like, only 10% of financial professional make it through 4 years in the business.  I’ve heard tons of stats that all seem to be slightly different.  This is how the big companies in financial services train.  They train people to sell products, as much as possible, as quickly as possible.  Who benefits from this?

This is all I think of when people tell me they do everything.  I was trained this way.  “Don’t leave money on the table” was what an old manager use to say.  How sad is that?  I couldn’t run my business this way so I changed but most people don’t and they might never.  I have learned one thing, the best advisers I meet niche.  They have their specialties and work with other specialists.  It might be fee only planing and they work with the product people.  It might be people insurance people that work with investment people or the investment people that work with the planning people.  The fact of the matter is that there is too much to know in the financial industry.  There are too many areas and too many situations to be able to handle them all.

So when you sit down with your adviser or you meet a new adviser, can they admit what they don’t know? Do they have help and support of specialists not only behind the scenes?  By the way that is what most advisers will say, “oh we have a group of specialists available to me”.  Most of the time that means, “I’m on my own I just want to seem like it’s more than just me”.  Next time you hear an adviser talk about all the things he/she knows and all the areas they can help you just realize that you might be talking to an expert at nothing.

How many hats is your financial professional wearing?

Related posts:

1. Your Ideal Financial Planner

Four years ago a woman named “Jane” had a problem.  She was receiving payments as part of a buyout from her husband’s business.  Her dilemma was how to replace the payments she was receiving while also trying to pass as much on to her kids as possible.  She was proud of her husband and the business that he created and passed on to their kids.  With all the hard work over the years if she wasn’t going to spend the money she wanted to make sure her family got as much as possible.

[As a side note she does have other assets and other income we are going to focus on one account for now]

Jane was about to turn 76.  The total sum of money that she had available was $300,000.  Her current accounts were $100,000 in a fixed annuity earning around 3.5% with Ameriprise, $120,000 in a few different CDs that were earning 3-4% and $80,000 in some mutual funds that an adviser had put together for her.  Are you with me so far?

What She Did

She put the full $300,000 into an AXA Equitable Accumulator, a variable annuity.  Then she added a couple of riders to her contract.  First she added a GMIB rider and then a death benefit rider.  We’ll get to those in a second.

Fees

That’s what everyone is thinking about and wondering about so let’s start there.  It is an annuity.  The basic contract has mortality and expenses associated with it totaling 1.25% per year.  The GMIB rider has an expense of 0.65% and the death benefit that she chose has an expense of 0.60%.  Getting expensive and we haven’t even added in the investments.  The investment expenses range from 0.64% to 3.65%.  Jane’s current portfolio is costing her 1.08%.  This brings the total charges on her contract to 3.58%.

Death Benefit Rider

The death benefit rider that Jane chose was the greater of 6% roll-up or annual ratchet to age 85.  During the first couple of years of the contract she was enjoying the annual ratchet.  With the lock-in in 2007 she was left with a death benefit of $380,000.  This meant that in 2008 when the market was falling, Jane’s death benefit on this contract was $380,000.  It was not subject to investment fluctuations.

Guaranteed Minimum Income Benefit

The GMIB rider that Jane chose gave her a base benefit that would roll-up by 6% per year.  She is required to hold the contract for 10 years after which point if she chooses she could annuitize off of the benefit amount regardless of her contract value.  For Jane this meant that she would start at $300,000.  She will earn 6% net of fees for her benefit amount.  So in the first year she would earn 6% of $300,000 or $18,000.  In the second year she will earn 6% of $318,000 or $19,080.  And so on.  Are you still with me?

Income

As we mentioned at the beginning Jane was going to be needing income in 2 years.  What this meant was that her account was allowed to do nothing but grow for the first two years.  In fact, with the market performance of 2006 and 2007 she found herself with a contract value of $380,000 and her benefit amount was $337,080.  Who needs this stinking safety net?  But now Jane needed income.  The way her GMIB works is that it allows her to take up to the 6% roll-up on her benefit on a dollar-for-dollar basis.  This meant that if she takes the 6% as income her benefit amount stays flat.  So this is what she did.  She took the 6% in the third contract year as monthly income and it came out to approximately $1,685 per month.

Taxes

Keep in mind that Jane had gains in this variable annuity due to market performance.  This was a non-qualified annuity which meant that the gains were taxable as ordinary income.  Annuities also follow LIFO which stand for last in, first out.  This means that all the gains come out before the contributions.  So when she began taking income in 2008 it was fully taxable and subject to a 20% withholding.  The checks she received then were for approximately $1,350.

2008 Market

Then 2008 hit.  The markets started to crash and they crashed fast.  Now because of her safety net, Jane chose to be a little bit more aggressive with this account.  She was actually in about a 65/35 splits towards equities.  The funny thing is today she has the same 65/35 split.  Her account is set to rebalance quarterly.  She just might need the safety net now.  Are the costs still too high?  The upside is that now she no longer has to worry about the taxability of her income since the gains in the account went away pretty quickly in 2008.

Today

Today she continues to receive her income of $1,685 per month.  Her account value is $255,000.  She started with $300,000 and has withdrawn about $40,000.  So it looks like she’s almost even.  Then we look at her benefit amount and it is $337,080.  Her death benefit was up to $380,000 using the ratchet feature but it has been reduced by the income she has received so today it is $340,000.  Remember that as she continues to take income this death benefit cannot fall below her contract benefit amount (the 6% roll-up).  One thing not to forget is that she can’t access that benefit amount until one of three things happens: 1. she passes away, 2. her account value drops to zero and 3. her 10th contract year (age 85).  This means she continues to receive her $1,685 per month until age 85 at which point she can then annuitize off the benefit amount which the contract estimates to provide $40,000 per year.  Not a bad pay raise.

What do you think?  Good deal?

**Disclaimer:  This is based on a true story.  Names have been changed and numbers adjusted slightly to make them more easier to work with.  All contract information was taken from the prospectus.  This contract is no longer offered.**

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