When to switch on an annuity income rider: waiting or starting now

Say Maria is 62 and owns a deferred annuity with a lifetime income rider. She retired last spring, her paycheck is gone, and the rider lets her start guaranteed withdrawals today. Her brother-in-law tells her to start now "before something goes wrong." Her neighbor tells her to wait because "every year you wait the check gets bigger." Both statements are partly true, and neither answers her question. The right start date depends on a handful of facts about her health, her other income, her spouse and the exact terms of her contract.

This post lays out those facts as criteria, works one example with the arithmetic shown, and ends with a decision list. All figures are hypothetical, chosen for clean arithmetic, and are not any insurer's terms. For the mechanics of the rider itself, read the guide to the guaranteed lifetime withdrawal benefit riders first, and for the two numbers underneath it, benefit base versus account value: the number income riders really use.

What actually changes when you wait

A guaranteed lifetime withdrawal benefit pays a percentage of a benefit base each year for life. Waiting can change two inputs to that multiplication:

1. The benefit base. Many contracts add a roll-up or "deferral credit" to the base for each year before the first withdrawal. Some stop it at a maximum number of years. Many stop it at the first withdrawal. Some let the base step up when the account value is higher on an anniversary.
2. The withdrawal percentage. Contracts usually set the percentage by your age on the date of the first withdrawal. Older starters get a higher percentage, often in bands such as 59 to 64, 65 to 69, 70 to 74 and 75 and older.

Waiting also changes three things that are not in the multiplication:

• Years of income you do not collect. Every year you wait, you give up a year of payments.
• Rider fees. The fee is usually charged on the base whether or not you take income. Waiting means paying it for more years, on a growing base.
• Risk. An unexpected health event, a death, or a change in the insurer's financial standing is more likely to matter the longer you wait.

So the question is not "does waiting pay more per year?" It almost always does. The question is whether the extra per year makes up for the years you gave up, given how long you are likely to live and what else you could do with the money in the meantime.

The illustrative contract

Say a hypothetical buyer put $250,000 into a deferred annuity with a lifetime income rider at age 60. The rider terms for this example:

• Roll-up: 5% simple, meaning $12,500 added to the base each year (5% of the original $250,000), for up to 10 years, and it stops at the first withdrawal.
• Withdrawal percentages by age at first withdrawal, single life: 4.5% for ages 60 to 64, 5.0% for 65 to 69, 6.0% for 70 to 74.
• Annual rider fee: 1.00% of the base.

Here is what each start age produces.

Check the arithmetic: at 65, the base is $250,000 + (5 × $12,500) = $312,500, and 5% of that is $15,625. At 70, the base is $250,000 + (10 × $12,500) = $375,000, and 6% of that is $22,500. The income at 70 is about 44% higher than at 65 ($22,500 ÷ $15,625 = 1.44), and about double the income at 60.

Notice that the jump from 65 to 70 comes from both inputs: the base grew by $62,500, and the percentage grew by one point.

The break-even question

The honest way to compare start dates is to ask how long you must live for the larger, later check to overtake the smaller, earlier one. Ignore fees, taxes and investment returns for a moment and use the table.

Starting at 62 versus 65. Starting at 62 pays $12,375 a year. Starting at 65 pays $15,625. The difference is $3,250 a year. By waiting until 65, Maria gives up three years of checks: 3 × $12,375 = $37,125. It takes $37,125 ÷ $3,250 = 11.4 years of the larger check to catch up, so the break-even is around age 76 and a half. If she lives past that, waiting delivered more total dollars. If she does not, starting early did.

Starting at 65 versus 70. Starting at 65 pays $15,625. Starting at 70 pays $22,500. The difference is $6,875 a year. Waiting five years gives up 5 × $15,625 = $78,125. The catch-up takes $78,125 ÷ $6,875 = 11.4 years after 70, so break-even is around 81 and a third.

Two features of these results are worth stating in plain words. First, the break-even ages are in the late 70s and early 80s, which is within the range of a healthy person's life but is far from certain. Second, the break-even shifts later when you count the fees. The rider fee is 1% of the base, and the waiter's base is larger, so the waiter pays more each year: 1% of $312,500 is $3,125 a year at the 65 start, against 1% of $375,000, or $3,750 a year, at the 70 start. The fees come out of the account, not out of the guaranteed check, so they matter most for what is left in the account and for how soon it runs down.

This arithmetic leaves out something the real decision includes: the break-even assumes the early starter simply spends the money. In the real world, the early starter might save part of the check, and the waiter might need to draw on other assets during the waiting years. The break-even is a starting point, not a verdict. Real contracts add wrinkles, such as step-ups that reward waiting in good markets, or roll-ups that stop sooner than ten years. Put your own contract's numbers through the same three steps: the difference in annual income, the years of income given up, and the years needed to catch up.

Criteria that favor starting sooner

• A need for the income now. If the alternative to starting is drawing from savings at a pace that will not last, the guarantee has already earned its keep.
• Health that shortens the likely time horizon. A serious diagnosis or a family history of early death moves the break-even beyond the likely lifespan. The life expectancy calculator gives a rough population-level sense, not a prediction for any person.
• A short or capped roll-up. If the contract's deferral credit stops after a few years, or if it is already used up, waiting buys little beyond the age-band percentage.
• A withdrawal percentage that does not rise much by age. In some contracts, the percentage bands are narrow.
• A concern about the insurer or the contract. If you worry about the insurer's strength or the possibility that the rules change, collecting sooner reduces exposure.
• No bequest motive. Withdrawals reduce the account value that would pass to heirs, so those who want to leave the account intact have a reason to delay. Those who do not have no such reason.

Criteria that favor waiting

• Other income covers the bills. A pension, a spouse's earnings, Social Security or a part-time job can carry the household for a few more years.
• Good health and a long-lived family. Longevity is the risk the rider insures, and the rider pays most to those who live long.
• A generous roll-up that is still running. Each year of roll-up in the example added $12,500 to the base, and each year of age added to the percentage.
• A surviving spouse who is younger. On joint coverage, the payment is based on the younger spouse's age in many contracts, and the withdrawal percentage is lower. Waiting can raise the joint percentage meaningfully, and coverage will run longer. The joint and survivor annuity comparison in a plain income annuity shows the same trade.
• A plan to bridge to a larger Social Security benefit. Using savings or a short income stream in the early years, in order to delay Social Security, can raise lifetime income. See A short income annuity as a bridge to delayed Social Security for how that bridge is built.
• Worry about running out of money in the late 80s and 90s. A higher guaranteed check that arrives later is a way to insure that tail.

Other income and taxes

How the withdrawals are taxed changes the net effect of timing.

For a non-qualified annuity, withdrawals come out earnings first and are taxed as ordinary income until the gain is exhausted; only then does the return of your own basis begin. If the account has grown only a little, a large part of each early withdrawal may be basis and tax-free, while a larger later check from a grown account may be mostly taxable. how annuities are taxed explains this sequence.

For a qualified annuity held in an IRA, every dollar is generally taxable, and required minimum distributions start at age 73, rising to 75 for those born in 1960 or later. The rules for how the rider's value enters the RMD calculation are specific; the guide on Should you put an annuity in an IRA? is a starting point, and a tax professional should run the numbers. If you must take distributions anyway, the best start date may be dictated by the RMD calendar.

Two further tax points apply to both. A larger guaranteed check can push income into a higher bracket or change how much of Social Security is taxable or what Medicare premiums are, so the "bigger later" check is not always bigger after tax. And, before age 59½, taxable withdrawals from most annuities can carry an additional 10% tax unless an exception applies. Every start age in this example is past 59½, but a buyer who is younger than that should ask before starting.

Health and the pooling logic

A lifetime income rider is a form of longevity insurance, and insurance works by pooling. Those who live a long time collect more than those who do not. If your health suggests you will not be among the long-lived, the pool's logic works against waiting, because the extra you earn by waiting accrues to survivors. If your health and family history suggest a long life, the same logic favors waiting.

There is no way to be certain about either. Two honest points follow. First, the downside is asymmetric in a way people often misjudge: starting early and living very long means a lower check for a very long time, while waiting and dying early means collecting less overall. Second, the decision need not be all or nothing. If the contract allows, and many do, you can start the guaranteed withdrawals and keep the rest of your savings flexible, or you can wait and use other savings first. A fee-only planner can model both.

The cost of getting the order wrong

Three mistakes show up repeatedly.

1. Starting withdrawals by accident. Some contracts treat any withdrawal as the first withdrawal under the rider, which stops the roll-up and sets the percentage band. Taking a one-time $5,000 for a car repair in year four can lock in a lower income for life. Ask what counts as a withdrawal for rider purposes before touching the account.
2. Starting just before an age band. If the percentage rises at 70 and the buyer is 69 and 10 months, starting now rather than in two months may lock in the lower band. The contract defines age by birthday or by contract anniversary, and it varies.
3. Taking more than the allowed amount. Once withdrawals begin, a withdrawal above the allowed annual amount can reduce the base proportionally. benefit base versus account value: the number income riders really use works through that arithmetic.

A decision list

Work through these in order and note the answers. They are meant to organize a conversation with a planner, not to produce a verdict.

1. Do I need the income now to pay bills, or am I drawing savings I would rather keep? - If I need it and the savings would run short, lean toward starting. - If other income covers the bills, continue.
2. Is my health, or my family's pattern of longevity, a reason to expect a shorter or a longer life than average? - Shorter: lean toward starting. Longer: lean toward waiting.
3. Is the roll-up still running, and what does the contract say about when it stops? - If it has stopped or will stop at the first withdrawal anyway, the case for waiting is mostly the age band. - If it runs for years more, compute the table above for each start age.
4. What is the break-even age for the next band, and how do I feel about it? - If the break-even is past the age I am likely to reach, lean toward starting. - If it falls well within my family's typical lifespan, lean toward waiting.
5. Is there a spouse, and which coverage did we choose? - On joint coverage, check the younger spouse's age and the survivor rules. A younger spouse often argues for waiting.
6. What are the tax effects for my kind of annuity, and what happens to Social Security taxation and Medicare premiums? - If I do not know, I get a tax professional's estimate before starting.
7. Do I want the account to pass to heirs? - If yes, lean toward waiting and toward drawing other assets first. If not, this does not weigh on timing.
8. Is there anything about the insurer or the contract that makes me uneasy? - If yes, ask the insurer and my state insurance department about the contract's terms and the company's standing.

If the answers split evenly, a middle path is available in many contracts: wait until the next age band, and meanwhile use other savings or a short-term income source to cover the gap.

When to get professional help

A fee-only financial planner can model the start dates against your full picture, including Social Security timing, taxes and the rest of your portfolio. A tax professional should look at the interaction of annuity income with other income, and an advisor who sold you the contract should be able to put in writing the roll-up rules, the age bands and what counts as a first withdrawal. If a sale seems to have been made on the basis of misleading guarantees, your state insurance department takes complaints.

Key takeaways

• Waiting usually raises the guaranteed check through a larger base and a higher withdrawal percentage, but it costs the checks you did not collect and more years of rider fees.
• A break-even calculation, shown above, tells you how long you must live for the later start to win. In the example it falls around 76 to 81, before fees and taxes.
• Starting sooner suits those who need the income, have health concerns or have a capped roll-up. Waiting suits those with other income, good health and a roll-up that is still running.
• Check what counts as the first withdrawal, how age is measured and how your annuity type is taxed before touching the account.
• Treat the decision as one input to a wider retirement plan, and ask a planner or tax professional to run your own numbers.