Bonuses, rollup rates, income-doublers, payout rates… It’s all noise. What do you really get out of an annuity for every dollar you put in?
Recently, a prospective client came into the office and was interested in discussing annuities. He said he and his wife were looking at an annuity that offered a 7% bonus and guaranteed 10% interest. However, before the prospect bought this annuity, he wanted to see what we had to offer.
When I said, “What we have to offer you is an education,” he was somewhat surprised. You see, the prospect needed to learn how to decode the complicated math behind the guarantees offered in annuities and how to access the guaranteed features.
Access to these guaranteed features could be granted in two ways: an income stream or a death benefit. For the purposes of this discussion, let’s focus on the income benefits. To my knowledge, none of these guaranteed values are offered in a lump sum at the end of the contract, and these values must be used for an income stream or inherited as a death benefit.
Since the insurance company is not actually guaranteeing anyone 10%, the word “guaranteed” should be replaced by “rollup rate.” Furthermore, some insurance companies offer compounded rollup rates, while some offer simple interest rollup rates. This makes a huge difference in how the annuity owner benefits. Let’s compare two annuities below, one with 10% simple interest for 10 years and one with 7% compounding interest for 10 years.
- 10% Simple Interest
100,000 + 10% simple interest for 10 years would look like this. $100,000 + $10,000 per year for 10 years would give you $200,000. This $200,000 would be the base used for calculating the income payments offered by the “guarantees.” $100,000 grown at 10% per year for 10 years with compounding interest would actually reach a value of $259,374 dollars, a $59,374 difference.
- 7% Compounded Interest
100,000 + 7% compounded interest for 10 years would reach a value of $196,715 at the end of 10 years. $196,715 would be the base used for calculating income payments offered by the “guarantees.”
Notice that the basis for calculating income on the annuity with the 10% guarantee is $200,000 while the income basis for the annuity with the 7% guarantee is $196,715. That is only a difference of $3,284.
Now that we have an understanding of the rollup rates and how they work, let’s see how we actually benefit. To understand the income benefits, we need to look at the payout factors. Payout factors are based on the age of the annuity owner at the time income payment streams begin. For instance, someone at age 60 may have a payout of 4%, while someone at age 65 may have a payout rate of 5%. The annuity discussed above with the 10% guarantee offers a 4.5% payout to someone at age 65, while the annuity with the 7% guarantee offers a payout rate of 5.5% to someone at age 65. Let’s apply those payout factors to our income basis from the two annuities we are comparing.
- 10% Simple Interest “Guarantee”
$200,000 * 4.5% = $9,000 in annually guaranteed income as long as the annuity owner has breath in their body.
- 7% Compound Interest “Guarantee”
$196,715 * 5.5% = $10,819 in annually guaranteed income as long as the annuity owner has breath in their body.
Notice the $1,819 difference in annual income between the two annuities. The annuity with the 7% “guarantee” and 5% bonus pays $1,819 more per year in annual income than the annuity with the 10% guarantee and 7% bonus. When it comes to selecting annuities for income, we have to remember one thing: The large bonus upfront and rollup rate/guarantee rate mean absolutely nothing. The only thing that matters when selecting annuities to provide guaranteed income is finding out how much income you get in the future for every dollar you put in. We want the least amount of money invested to produce the largest income benefit in the future.
Guaranteed lifetime income streams during your golden years are hugely beneficial. With all the buzz of large bonuses, large rollup/guarantee rates, and other bells and whistles, it is best to work with an advisor who is licensed with multiple insurance carriers. The advisor should allow these carriers to bid for your money. The carrier with the largest amount of income offered for every dollar invested and the best ratings is the company you should place your hard earned money with.