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Case Study – Annuity A Vs Annuity B

Now that we have established the Ground Rules and discussed the Decision Tools for Annuity Analysis, let’s put those tools to good use and examine two annuity products that are popular in today’s market. 

 

We’ll simply call these Annuity A and Annuity B. I assure you, these are actual products that are being sold by the thousands. To re-cap, the critical provisions to make an annuity decision are:

Surrender Schedule,

Free withdrawals,

Interest Rates, including

 
Guaranteed minimum rates,
 
Current Rate
 
Renewal Rate
 
Yield to Surrender

Premium Bonus Rates.

Corporate Credit

There is a lot of contrast on these issues in the annuities I have chosen for this example. Tale of the Tape:

 

Annuity A

Annuity B

Bonus

10%

0%

Current Rate

3.75%

5.60%

Minimum Guarantee

1.50%

6.25%

Surrender Period

10 years

7 Years

Principal Amount

100,000

100,000

Agent Commission

9%

3%

Free Withdrawal

5%

10%

The differences between these annuities jump out when laid side by side. We’ll discuss each one…

Annuity A The premium bonus for Annuity A is quite attractive and is most likely it’s big selling point. The obvious downside is that you must wait an extra three years for the surrender schedule to expire. You also contend with limited liquidity thru a smaller free withdrawal. Take a look too at Annuity A’s cost of placement- this is the total cost to the insurance company to sell this annuity. Between the premium bonus and the agent commission, the company is down 19% before it even gets started!!! What’s the conclusion?? The company will make up for those costs by holding on to your money for ten years, offering you very little liquidity and guaranteeing a pretty low minimum rate. It may be one of the only annuity choices your agent shows you, however, because the commission is juicy.

Annuity B- Annuity B on the other hand, has only 3% lost to placement costs. Because of the lower expenses, you get a more solid guaranteed rate, shorter surrender schedule and more liquidity via free withdrawals. Conclusion? Annuity B gets no love because of its low commission, but its high guaranteed rate indicates that management is confident in their long-term ability to deliver on their promises. So what annuity is best for you? To determine that, let’s put Annuity A and Annuity B in a spreadsheet to see how the long-term performance looks for each product. These Spreadsheets are available on our Downloads Page

Below, you will see each annuity’s yield to surrender based on both current and guaranteed rates, the surrender value in each year and the ending account value. Just so you know, Annuity B’s surrender schedule will expire in year seven but I went ahead and illustrated the returns over ten years in order to keep things as even as possible.

 Annuity A5% annual free withdrawal

End Of

Current Rate

Guaranteed Rate

Surrender Charge

Surrender Value

Year 1

$113,750

$113,750

10%

$102,375.0

Year 2

$118,016

$115,456

9%

$107,394.22

Year 3

$122,441

$117,188

9%

$111,421.50

Year 4

$127,033

$118,946

8%

$116,870.14

Year 5

$131,796

$120,730

7%

$122,570.73

Year 6

$136,739

$122,541

6%

$128,534.52

Year 7

$141,867

$124,379

5%

$134,773.23

Year 8

$147,187

$126,245

4%

$141,299.09

Year 9

$152,706

$128,139

3%

$148,124.87

Year 10

$158,433

$130,061

2%

$155,263.88

Yield to Surrender

4.71%

2.66%

  

A Link to the Excel Spreadsheet that calculates this table is available on our Downloads Page

 

Annuity B

10% annual free withdrawal

End Of

Current

Guarantee

Surrender Charge

Surrender Value

Year 1

$105,600

$105,600

7%

$98,208

Year 2

$111,514

$112,200

6%

$104,823

Year 3

$117,758

$119,213

5%

$111,870

Year 4

$124,353

$126,663

4%

$119,379

Year 5

$131,317

$134,580

3%

$127,377

Year 6

$138,670

$142,991

2%

$135,897

Year 7

$146,436

$151,928

1%

$144,971

Year 8

$154,636

$161,423

 

$154,636

Year 9

$163,296

$171,512

 

$163,296

Year 10

$172,440

$182,232

 

$172,440

Yield to Surrender

5.60%

6.18%

  

Okay, what differences do you notice?

The end result? Annuity B looks boring and pays a lower commission, but offers a higher yield to surrender and higher account value than Annuity A.
The premium bonus that entices annuity buyers is often offered in conjunction with high commission. Premium bonuses should not be a deciding factor in an annuity buying decision unless to break a tie between two equal offerings. But it’s important to see how they are used.
In deciding, you must consider only your best interests. The high commission, high bonus, but shortsighted approach used to sell Annuity A costs you freedom, liquidity and profitability. Your money is locked up with a smaller free withdrawal and bound by a high surrender charge. You can’t get your money back, and your appreciation rate on it is pretty small. Even still, the agent made a hefty commission.
  

Action Items:

The end result? Annuity B looks boring and pays a lower commission, but offers a higher yield to surrender and higher account value than Annuity A.
The premium bonus that entices annuity buyers is often offered in conjunction with high commission. Premium bonuses should not be a deciding factor in an annuity buying decision unless to break a tie between two equal offerings. But it’s important to see how they are used.
In deciding, you must consider only your best interests. The high commission, high bonus, but shortsighted approach used to sell Annuity A costs you freedom, liquidity and profitability. Your money is locked up with a smaller free withdrawal and bound by a high surrender charge. You can’t get your money back, and your appreciation rate on it is pretty small. Even still, the agent made a hefty commission.
  

That’s not the kind of analysis most advisors will give you.

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Fixed Annuity Rates

Fixed annuity rates are probably the easiest among all the types of annuity contracts to understand. You deposit money with an insurance company and commit to leaving it there for a certain time period. When that time period has passed, your money will be returned plus interest. There are, of course, other important details but we’re talking about annuity rates so let’s stay on point.

As simple as fixed annuities seem, there are a wide variety of rates that can be applied to each contract. Each type of rate is listed below with an explanation of how it affects a fixed annuity contract.

Fixed Annuity Rates Components:

Multi-Year Guaranteed Rate- This is a type of annuity contract all its own that is often referred to as a CD-type annuity. That’s simply because the contract comes with a declared rate that is guaranteed never to change over the time period.

Current Rate-Other fixed annuity contracts offer a current rate of interest that is good for a portion of the overall time period. Usually that’s one year, at which time a new current rate is declared for the next year.

Renewal Rate- This the rate declared on each contract anniversary that will be applied to existing contracts where multi-year guarantees are not applicable.

Guaranteed Minimum Rate- This is the contractual minimum interest rate that can be declared for renewal of existing contracts. As rates change annually, insurance companies offer this minimum so you can always expect to receive at least this rate and no less.

Bailout Rate- Very few contracts offer this option. This sets a benchmark rate, usually just above the guaranteed minimum that allows you to leave the contract without penalty if the renewal rate ever dips below.

Bonus Rate– Here you have nothing more than additional interest credited to the account when the contract is issued.

Yield to Maturity- Most important of all, this tells you actually what to expect for a total yield in the contract and is the best way to truly compare two fixed annuities. When all growth rates are factored in, what’s your cash on cash rate of return? There are a few different ways to do this.

  • With multi-year guarantees the rate never changes so the Yield To Maturity (YTM) is identical to the guaranteed rate.
  • Current yield to maturity takes into account the effective yield assuming the declared interest rate will be stable throughout the term.
  • Guaranteed yield to maturity assumes the current rate is only good for one year and all following years will revert to the guaranteed minimum rate for the remainder of the term.
  • **All yield to maturity figures would need to be adjusted upwards if a bonus is included with the contract.

Fixed Annuity Rates Summary:

As you can see, there are potentially several rates you’ll need to understand in order to properly evaluate the growth potential of any fixed annuity you may consider. Take the analysis step by step to make sure you understand exactly what kind of deal you’re getting.

Also be sure to shop around as there are literally hundreds upon hundreds of available fixed annuity contracts when all companies and surrender periods are considered. If this seems like a major challenge, relax; we’re always available to help you find the best fixed annuity rates and the most appropriate solution to your situation.