Key Takeaways
- Hybrid annuities are a product combining the benefits of both guaranteed and non-guaranteed features.
- Hybrid annuities can have higher fees than other, simpler annuity contracts.
- There are many options to customize the income and guarantees on your hybrid annuity, which can make it useful for individuals with specific needs.
What Are Hybrid Annuities?
While there are numerous types of annuities to consider, hybrid annuities stand out as a unique product. They combine the advantages of two different kinds of annuity products into a single package, with some also offering an income rider as an additional feature. Hybrid annuities are not a separate or distinct category of annuity products, rather the convenient pairing of existing products that consumers could purchase separately. However, many companies offer this product as a hybrid annuity.
The most popular type of hybrid annuity is the indexed annuity, which offers the benefits of combining both guaranteed and non-guaranteed features. Together this provides a balance of stable, guaranteed return (fixed annuity) and a variable growth component, which can involve tracking a market index or investing directly into mutual funds (variable annuity). While the combination of two types of annuities can offer the “best of both worlds”, the new product can become significantly more complex. Consumers should be cautious and make sure they understand this before making a purchase.
Can All Types Be Combined?
There are many different types of hybrid annuities, each one created to target a specific need and offer different combinations of benefits for consumers. Hybrid annuities often seek to balance growth, flexibility, guarantees and income in a way that simpler annuities may not.
However, creating hybrid annuities isn’t as easy as combining features. Most insurance companies create them as custom standalone offerings based on the use of two or more underlying policy features, such as adding an income rider or benefit rider to a variable indexed annuity. Due to the complexity of these insurance products, consumers may consider working with an insurance agent or broker to help them determine the policies most suitable for their personal and financial circumstances.
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How Hybrid Annuities Work
To understand more about how these annuities work, we can review some of their features and benefits.
The basis for most hybrid policies is the indexed annuity. These policies will pay interest based on the underlying performance of a specific market index, such as the S&P 500. This allows the owner to benefit from the growth of the underlying market while still retaining some downside protection if the market performs poorly. Moreover, many indexed annuities will credit a minimum interest rate, and also cap the upside performance. This implies that, no matter how strongly the chosen market index performs, the annuity holder won’t receive returns surpassing a specified percentage, as stipulated in the annuity contract.
To transform a standard annuity into a hybrid annuity, an income or benefit rider is included in the policy to increase the amount of guaranteed income. This distinction from a deferred annuity is important because it allows the owner to retain control over the underlying contract value.
- Guaranteed Minimum Income Benefit Rider
- When paired with an indexed annuity, an income rider sets a minimum level of income for the owner in the future and creates the opportunity for the owner to withdraw the greater of the guarantee amount from the income rider benefit or the annuitized value of the underlying contract.
- Guaranteed Minimum Accumulation Benefit Rider
- It sets a minimum level of guaranteed accumulation in the owner’s income account after a specified period, typically 7-10 years. If the contract value remains below this minimum threshold after the specified term, the insurance company will make up the difference.
- Guaranteed Minimum Withdrawal Benefit Rider
- Similar to a Guaranteed Minimum Income Benefit Rider, this option permits the annuity owner to annually withdraw a maximum amount from the annuity, regardless of the investment performance of the underlying contract.
- Guaranteed Lifetime Withdrawal Benefit
- It sets a guaranteed percentage that can be withdrawn from the contract each year, typically 4-8%, depending on the annuitant’s age, for as long as the annuitant is alive.
Rider Types
Unique Time Horizons and Liquidity
Due to the underlying variable and market-based investments in the annuity contract, time will be an asset for the policy owner. These products should be used by investors with a long-term time frame for investment. To avoid the need for early withdrawals before locking in guarantees, it’s important to align these thresholds, such as the Guaranteed Minimum Accumulation Benefit, with the investor’s income plan.
Indexed annuities, including hybrid annuities, are primarily designed for individuals with a long-term time horizon. Premature withdrawals from these annuity contracts may result in penalties, surrender charges or losses. Once the contract is annuitized, the lump sum is unlikely to be available. Most variable annuities have surrender charges that decrease annually and expire within the first 7-10 years after purchase.
Pros and Cons of Hybrid Annuities
The key advantage of hybrid annuity contracts lies in their ability to introduce flexibility into what are typically rigid annuity contracts. They empower owners with a degree of customization and control over their investment risk and income protection, a level of control that individual policies like fixed or variable deferred annuities or income annuities do not provide.The availability of benefit riders allows for personalization in terms of income guarantees and other options, such as long-term care.
The drawbacks of these policies are their cost and complexity. Paying for flexibility and customization can result in additional annual fees ranging from 0.5% to 2.0%. The guarantees provided by the benefit riders come at a price. Moreover, the stringent rules and stipulations that govern how these guarantees are applied can be challenging to comprehend and may offset the benefits in relation to the cost.
Who Is a Hybrid Annuity Right For?
There is no one-size-fits-all product that is universally right or wrong for consumers. Individual preferences, risk tolerance, income needs and longevity all factor into how we evaluate product choices. Hybrid annuities can serve as a component within an income portfolio for future retirees. To harness the advantages of market exposure, these hybrid policies require time to accumulate and activate income guarantee triggers. Individuals with more than five years until retirement may find these policies suitable. Longer investment timeframes tend to maximize their benefits. However, if you seek immediate income, hybrid policies may not be the ideal choice.
Hybrid annuities can empower them with the confidence to assume more investment risk by incorporating additional guarantees. If adding guaranteed return or withdrawal options allows a retiree to tolerate greater market risk, a hybrid policy may serve as a viable choice for providing effective inflation protection.
It’s advisable not to buy a policy that you can’t easily explain to a friend or spouse. If the policy is overly complex and confusing, it may not be the right choice for you.
Important Considerations When Deciding on a Hybrid Annuity
When creating an income plan, using the minimum guarantees as the basis for the expected income will allow consumers to benefit from the upside and not suffer if the variable returns do not outperform. It’s advisable to not rely on optimistic non-guaranteed projections as the foundation for an income plan. This may leave consumers with less than they expect.
FAQs About Hybrid Annuities
The main reasons someone would purchase any annuity is to have tax-deferred growth and an additional source of lifetime income for retirement planning. Annuities offer guaranteed income or rates of return to minimize investment risk.
On the variable portion of your annuity, there will be both a minimum rate of return (floor) and a maximum rate of return (ceiling). Your actual return will be one of these or in between depending on the performance of the market index. The income base will have a specified growth rate that will grow until annuitization occurs.
Hybrid annuity policies may have multiple fees layered together. It is important to understand the total fees you will be charged. For instance, there may be a fee for the underlying investment option, mortality charges, as well as the fee for the income or benefit rider(s). Together these can add up and cut into your return or income.
A mortality and expense risk charge is a fee imposed on investors in annuities and other products offered by insurance companies. It compensates the insurer for any losses that it might suffer as a result of unexpected events, including the death of the annuity holder.
Fee charges will depend on the insurance company, which is creating the specific annuity product. Some may charge the fees monthly, while others will do it annually. Ask your broker or agent how fees will be charged and how they will impact your long-term return or income expectations.
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