With interest rates coming up there are a lot of good deals for safe money. Bonds, CDs, money market and annuities have better deals available than any of those had for the past ten years. You all have a wide variety of options to choose from and each works for different purposes. This may sound like me stating an opinion as fact but annuities are the best option for most uses in retirement. If anyone wants me to go into all the reasoning behind that claim I’d be happy to engage in the debate or even run a series of podcasts to remind everyone.
For now I’m going to focus on what has changed in the annuity market and more specifically in relation to bonuses offered on many contracts. Everyone knows that nothing in the financial world comes for free, aside from a cheap gift you might get for opening a checking account. Bonuses exist to catch your attention and are used by novice salespeople and advisors as the most prominent part of a sales pitch.
I have been skeptical about bonuses from the early days of my career. One opportunistic agent in my office was selling a ten year fixed annuity with a 10% bonus. The guaranteed interest rate for ten years was around 3% so including the bonus, the average yield over the term was a touch over 4%. At the time a fixed annuity with no bonus was paying closer to 7% guaranteed for the same term so you can tell me which the better deal is. He sold more annuities than me because he had flashier bait.
Before this goes any further, I should probably mention that there are two different types of bonuses. There is a true bonus that goes directly to your accumulated value and there is a phantom bonus that only increases an additional benefit in the contract, like guaranteed lifetime income. It’s not really called a phantom bonus but it’s a good descriptor because a lot of agents don’t clarify the benefit and a lot of people don’t ask the right questions.
All bonuses take a little something else from the contract and it makes sense. Insurance companies didn’t become the most stable financial institutions by giving away money. A phantom bonus that increases guaranteed income or a death benefit will come with lower payout rates, less growth and higher fees. Below is a line from an insurance company that puts this out there for everyone to see.
Because this is a bonus annuity, it may include higher surrender charges, longer surrender charge periods, lower caps, higher spreads, or other restrictions that are not included in similar annuities that don’t offer a bonus.
There are no exceptions to this. A true bonus that only increases cash value will come with much lower growth potential, much like the story above about fixed annuities 20 years ago. Fixed indexed annuities are no different. In some cases the bonus is available to use for free withdrawals and other times there is a long vesting schedule. I have a client who bought a bonus annuity from someone else nearly 12 years ago. The surrender period was only ten years but the vesting period for the bonus is 16 years. It essentially added six years to the surrender term. Buyer beware – there’s always something more to an annuity that includes a bonus.
But, rising interest rates is where this really gets interesting. Fixed annuities have better guarantees, indexed annuities have higher growth potential and bonuses are getting bigger but they still mean the same thing. Along with better interest rates right now you’re going to see a lot of tomfoolery in this market. People have been debating this with me recently and it’s kind of like a kid telling me that Santa Claus is real. I learned all this a long time ago and misunderstanding reality in this case can damage your retirement plans, while believing in a mythical gift giver is fun and relatively harmless.
Here’s an example of one of these conversations. I’ve been told, “you said the best rate on a fixed annuity is around 4%. But someone came to my house and showed me a contract with a 10% bonus that’s guaranteed to gain 7% every year.” I’m sorry but those are phantom rates and only affect an income value, not the amount of money you have.
Bonuses do enhance annuities and are appropriate at times, but the advantages are so specific that an individual contract only works best in unique circumstances. In the vast majority of situations you are better off just sticking with the highest growth potential. Multi-year guaranteed fixed annuities and fixed indexed annuities are going to pay more in the long run if you keep it simple and skip the bonus.
Just like any other topic this is kept somewhat general so I can deliver the message efficiently. If you want to nitpick one detail or another then respond to the email or comment below. As a reminder, you can comment on the website anonymously by typing in a pseudonym. Have a great weekend and call me next week if you need anything specific.