Sunday, July 24, 2016

Annuity Payment Increase Benefit

Our financial advisor warned us not to take the “Annuity Payment Increase Benefit”. It would take much more money in the pot then to have equal payments. This sounded strange to me. If we reduce the initial years of payments, it seemed to me, there would be more money for later payments at no additional costs. There are situations where this makes sense such as the fear of inflation.

The brochure states, “This benefit will automatically increase your annuity payments each contract year.” Then several lines about how the calculation is done with the section ending with, “These annual increases will continue until the annuity payments end.” The word “increase” appears six times in this marketing copy.

At the bottom of page 12 it states, “It may take some time before your annuity payments will equal or exceed the annuity payments under a contract without this benefit. Please see the chart on the next page.” (There are 6 increases to one whoops: promotion with one partial truth in advertising.)

The chart on page 13 (Chart 16) is not what I was expecting. It is what I call a “tourist” quality presentation. It gives you the idea but lets you seek out the specifics after you have arrived at the spot. Here we have to deal with the tradition of buying something and then having 10 days to return it if not satisfied.

The fulcrum in this chart is not in the center, but at about 13 years. But more disturbing is the area below the $500/month line, where we would be giving up money, which is much larger than the area above the $500/month line, where we would be getting back money.

What is entirely missing, but alluded to above, is the total payout for each option. Only the rate of the last payment is listed. This “benefit” has a cost that is not listed.

I need to sum the payments for 20 years for each benefit option. I have only the starting point and the ending point from the inaccurate artistic chart. My first trial was to draw a straight line between start and end rates (Chart 17). This is also simple interest. It is not a good fit. The fulcrum is at about 12 years. It is not at 10 years, half way from start to end of the contract.

I need to fit a sagging curve; not a straight line. Compound interest develops a sagging curve (Chart 18). The fulcrum is now at about 16 years and has long sagging lines leading up to something that looks about right.

[One day later] It occurred to me to put the starting values in the Pot to annuitize. Adjust the interest rate to span the gap between starting and ending values. The fit was almost perfect. The required interest rates ran from 0.85 for 1% to 7.5 for 5% benefit using my calculator.

Chart 20 is a complete surprise to me. The more that is given in the beginning years, to get an “increased payment” in later years, the smaller the total payout. Chart 20 estimates that it would cost about $7,000 to experience a 5% increased benefit on the illustrated $100,000 contract.

An interest rate of 1.8% would yield the $500/month or $6,000/year on the $100,000 pot in 20 years shown in the illustration. The total payout would be $6,000 x 20 or $120,000, without the increase benefit and the for-life options.

I would like to know if I am really right on this, or is the marketing a clue of what is, in my opinion, wrong here. To match this contract, with a 5% inflation rate, with the contract we are negotiating (10 years certain and no life insurance included), we would need to put up a pot of about double the money and lose about $14,000. I can agree with our financial advisor on this but I do not understand it. Guardian Life is a highly regarded mutual company, like New York Life, or we would not be dealing with it.

I in no way see this as a “benefit”, something of greater or increased value. A better way, that was suggested by our first daughter in law, was to select a constant rate (as we have) and, when the monthly payment is not needed, to reinvest it. Then we would hold and manage the unneeded money rather than the insurance company. It should not cost us several thousand dollars per year to do this.

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