Guaranteed Minimum Annuity Values
The effects of higher interest rates on annuities has been a popular topic. Today I’m going to share some insight into guaranteed minimum annuity values, which may not look like much on the surface but it should give some assurance to first time annuity buyers. Those who have never owned an indexed annuity are justifiably skeptical of how it will work out. Many assume that market timing and the contract components all have to be just right in order to make money. It usually averages out just fine over time but that’s something you can’t know before you buy one.
Back in the day, as in 15-20 years ago, most contracts had a guaranteed minimum rate of say 3% for example. So you could get the greater of 3% or the index return. It was a great worst-case scenario but rates were much higher then, when insurance companies could use good yield to build more value in several areas of the contract. I don’t mean to say that annuities now are a bad deal. On the contrary, what’s available now is reflective of the current market for options and bond yields. It’s just the world we live in today.
Rates really didn’t start rising until about March last year so we are about a year into it. Since then we’ve covered everything from better income payouts to higher fixed rates and growth potential on fixed indexed annuities. People who have been around for a while realize how good it’s been and hopefully those new to it don’t wait too long. Aside from the topside, however, there is one important place where more value has been added, guaranteed minimum returns.
In every illustration, there is a page that specifies the guaranteed minimums in the contract. I use it to prove to people that they will never pay fees and never lose money. Every penny that goes into the contract is guaranteed to be there in full at the end of the surrender period, less any withdrawals taken, of course. No one ever got too excited about it but it is a very important part of the illustration. I’ve seen too many other agents disregard this page altogether and only mention the potential upside, but that isn’t guaranteed.
There is a difference between the surrender value and the guaranteed minimum surrender value. Let’s define those so that everyone understands.
Surrender Value: Account value, less prior withdrawals and the surrender charge. The percentage charge declines over time so this slowly rises to equal total premium less withdrawals at the end of the surrender period.
Market Value Adjustment (MVA): An important additional component that adds an adjustment to the surrender value, based on interest rate changes since the purchase date. The MVA can be positive or negative in favor of the contract owner, which can eliminate surrender fees or make them higher. It shifts some risk of bond devaluations to the contract owner but it only applies to a full surrender or amounts in excess of the annual free allowance. The MVA is null and void once the surrender period ends.
Minimum Guaranteed Surrender Value (MGSV): This is a minimum surrender value when both surrender fees and an MVA are applied against the contract. Annuities are highly regulated in each state and this is a mandated minimum value that protects consumers from the combination of surrender charges and a negative market value adjustment.
The MGSV is what I’m going to point out because that’s the true guarantee that’s much higher than it was a year ago. Let’s forget withdrawals here for a minute. Traditionally, the MGSV has been calculated as 87.5% of premiums paid, compounding at 1-3% annually. Each company declares a rate between one and three percent each year that applies to all new contracts issued. We entered last year with very low benchmark rates so the declared compounding factor was only 1%. All companies have increased that rate substantially, closer to 3% and that means guaranteed growth, not just a guarantee to get your money back.
If you put $100,000 in a contract one year ago, you were guaranteed to get $100,000 back at the end of the surrender term. If you buy it this year, that guarantee rises to about $117,000, depending on the company. To be clear, it’s not a minimum guarantee plus your index earnings, it’s one or the other, whichever is higher.
I think it’s a cool way to demonstrate the additional value built into annuities when rates are higher but it is mostly irrelevant. I’ve never seen an indexed annuity that didn’t grow by a fair bit more than that. So you didn’t get robbed if you bought an annuity last year that didn’t have this. I’ll bet my last dollar that you’ll easily exceed the guaranteed minimum. And this only applies to fixed annuities that are surrendered early, because, if held through the surrender period, the fixed annuity rate would obviously be higher.
Aside from the basic value provided by the minimum guaranteed surrender value, this reinforces an idea I shared with you all last year. In episode 52, “Splitting Annuities”, I talked about the value of using both an indexed annuity and a fixed annuity for those who couldn’t decide which they were more comfortable using. Half the money with a nice guaranteed growth rate in a fixed annuity and half the money with more upside with the indexed annuity. It’s a great way to protect money and grow it as well as the option to use it for creating an income or RMD plan.
As it stands now, you can get about 5% on the fixed annuity and guarantee that for a period of years. Let’s say the minimum guaranteed surrender value of the indexed annuity is 1.7% in a worst case scenario. The combination of the two products creates roughly a 3.3% yield on the whole basket of money and that’s a whole lot better than any fixed annuity that was available in early 2022. A solid guarantee on one side and substantial upside on the other side with no risk. It sounds like a retirement dream come true.
The worst case for an indexed annuity now is actually equivalent to cash sitting in a savings account or money market with the opportunity for much higher yields. I know rates on cash are quite a bit higher right now but they aren’t guaranteed to stay there and it’s a fairly recent phenomenon. I also know plenty of people who have been sitting in money market funds for several years without doing any better. It is a great time to buy annuities and this is just one more reason… guaranteed returns with plenty of upside.
Call or make an appointment if you’d like to dig deeper.