High Interest Annuities May Not Work How You Think They Do

by | Dec 17, 2014 | Podcasts, Financial Planning

Over the years we’ve fielded calls from people asking us different variations of this question: “I was offered an 8% guaranteed annuity by my insurance guy and wondered what you thought?”. That’s why Tom and Brendan decided to discuss high interest annuities on this week’s Mullooly Asset Management podcast. These products may not work the way many people believe they do. A lot of investors don’t fully understand them, and (sadly) neither do the people selling them.

What we’re really talking about in these instances is typically a variable annuity with an income rider attached to it.

Let’s break down the statement from above: “I was offered an 8% guaranteed annuity by my insurance guy and wondered what you thought?”.

– Yes, you were offered a guaranteed annuity by an insurance company.
– No, your money will not grow at 8% per year.

Nobody can get a guaranteed rate of 8% a year with Treasury yields under 3%. There’s a catch in this scenario, like there almost always is with annuities.

A lot of people don’t understand that there are two parts to these types of annuities: the accumulation value and the income rider value.

Two parts means two separate calculations and two separate sets of rules. The income rider calculation can only be used for income. This means you can’t tangibly take the 8% a year out of the account. You also can’t transfer that amount or take a lump sum distribution at the end of your surrender period. In order to get the income rider total, you have to annuitize the contract. In plain English: you trade ownership of your money for a monthly check from the insurance company.

Here’s a simple way to think of the two separate values these annuities have. The accumulation value is the real value, meaning you could take a lump sum at the end or transfer that amount. It is not guaranteed to make 8%, it makes whatever the underlying investments you select within the variable annuity do in a year. The income rider value is as good as phantom value. It’s getting 8%, but only if you agree to annuitize your contract and take a monthly check.

Now here’s an example with numbers:

– You start with $100,000
– Your surrender value is $120,000 after 10 years with ABC Insurance Company
– Your lifetime income value is $180,000 (8% simple interest credited over 10 years on $100,000)

Your options look like this:

– Take the $120,000 and do what you want with it (invest, spend, etc.)
– Take the income stream on $180,000 in monthly payments (no lump sum, no transfer, etc.)

Unless you plan on annuitizing the contract for the income stream, that advertised 8% is as good as Monopoly money. This saying goes for plenty of things, but most definitely applies for annuities: if it sounds too good to be true, it is.



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