7% Annuities

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This one takes me back to the very beginning of this website.  In the early years of my career, variable annuities came out with guaranteed income riders.  Since VAs have mutual fund sub-accounts the cash value of the contract goes up and down with the market.  But the guaranteed income rider assured the owner that future income would be based on a phantom number that increased regardless of market performance.  Many of you already know this and many who know it have experience with such products.  Some worked out well and some didn’t so I’m not here to convince anyone to regret a past decision but I do want to remind those who don’t know what 7% actually means.

Last week I highlighted a fixed annuity offer that had a boosted rate for the past few months.  It wasn’t the highest possible fixed rate on the market but considering credit quality of the insurer it was a very valuable offer.  That offer, of course, is relative to what’s available in today’s market.  Those who would rather accept risk might have thought the payoff wasn’t good enough and others may have liked the guarantee but thought the rate was too low for the commitment required.  Everyone has a choice to make and I’m here to help with the guaranteed side of things.

When I post things like that it’s common for some people to challenge me with a better offer found elsewhere, which drives me to justify my nature to be particular about the opportunities I support.  Some of you may recall there was an offer that expired last week with a 3.25% guaranteed rate.  That’s nothing more than an annual interest rate on your money.  It’s very simple.

One person responded by email asking if I had an opinion on a 7% annuity.  I knew what that meant but I assumed he may have thought that my offer was nearly four percent less than something else he had been pitched.  While several other mediocre companies are offering something that is a touch higher there is certainly nothing that offers a guaranteed yield of 7% when treasury rates are near zero.

I admit it is confusing because several companies are offering 7% yield or something similar, so what gives?  Well this goes back to the beginning for me.  To spare you the whole story, I’ll just cut to the numbers.

Your account value is the money you put into an annuity.  That value grows according to a fixed, indexed or variable rate of interest, depending on the type of annuity you choose.  The account value is your money that you can use for anything you want by way of up to 10% free withdrawal or the full sum at the end of the surrender period.

The income rider adds a guarantee that provides a phantom value with a guaranteed increase for each year of deferral.  In this case that guaranteed increase is 7% which means the phantom value grows by that amount each year until you take income payments.  When you take income, the phantom value has grown by 7% each year and then lifetime income is based on that accumulated value and the age at which you take income.  The older you are when income payments start, the higher percentage of the phantom value is guaranteed.

The cash value of the contract is quite different from the phantom value used to generate lifetime income.  When an annuity offers 7% it doesn’t mean that’s how your cash value grows.  It simply shows you how much your income will increase for each year you wait to take it.

7% or anything like it only refers to the deferred annuitization of your money and not the growth of your assets.  It may sound complicated but it’s not.  Everyone knows exactly what this means because everyone counts on social security for retirement income.

Social security is not an asset, it is income.  No one puts it in the asset column but everyone uses the income figure to reduce the burden on a retirement portfolio.  What happens with social security?  It’s just like the 7% annuity.  You are eligible to collect at age 62 but get more at 66 and two months and get the most at age 70.  Every year you wait means a guaranteed increase in the income you will receive.  Everyone loves social security but no one likes annuities.

Therein lies the problem.  For years agents have been selling the 7% guarantee without explaining what it really means.  Many people thought to expect a healthy yield on their investment each year, only to get a complicated statement that showed nothing close to it in cash value.  The biggest omission in all of this is that most all income riders also charge a fee that further reduces cash value.  I can’t count the hundreds of people who have called to tell me they were sold on a different idea.

If a guarantee matches your expectations then a lifetime income contract will work great.  But if you think you are making 7% on your money then you have to ask the salesman some hard questions.  Guaranteed income contracts work well when the guarantee matches expectations.  If your expectations are different then you need a second opinion.

I’m raising my hand…

Bryan

4 replies
    • Bryan Anderson
      Bryan Anderson says:

      Jason- I don’t know that you got screwed but it sounds like your expectations haven’t been met. It’s likely not in your best interests to cancel the contract if there are substantial fees for doing it but you may be able to cancel the income rider and save some money. It’s hard to say without knowing the details so let me know if you’d like to chat about it.

      Reply
  1. Gilbert Kunken
    Gilbert Kunken says:

    The discussion above prompted me to ask the following question. A friend of mine was telling me about a guaranteed 10% simple interest rate annuity he bought several years ago from First Nationwide. The 10% simple interest was allegedly guaranteed to be credited each year until he started to take payments. I suspect that correlates with a compounded annual interest of maybe 6-7%, still very attractive. The stated underlying guarantee was no less than 5.5% per year. Are you familiar with this product and if so, can a company maintain such a commitment for the next 20 plus years or more in the face of such a low current interest rate environment? Thank you.

    Reply
    • Bryan Anderson
      Bryan Anderson says:

      Gilbert,

      You are correct that simple interest equates to around 7% compounded. There are several different ways a company will do it. As far as the underlying growth, it would depend on when the contract was issued. I’ve seen others with a very rich guarantee and it’s likely feasible for the company because relatively few people held on to those contracts and the investments backing it are also long-term based on rates of the past. Companies are required to project long-term liabilities so as long as the company has good strength ratings then your friend’s contract is factored into that and should be fine. Thanks for the question. It seems like your friend has a really nice deal.

      Reply

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