You may have heard about “bonus annuities,” or maybe there is a financial advisor that is recommending you purchase a bonus annuity.
Before you purchase one, stop and think about it. Then see if it is in fact a good deal. If the bonus annuity is a good deal, the next step is to see if it makes sense in your retirement plan.
What Is A Bonus Annuity?
A bonus annuity is an annuity where the insurance company pays you an upfront bonus on your deposits. A bonus annuity can be either a variable annuity or a fixed annuity. It really doesn’t matter.
The insurance company may give you a bonus that ranges anywhere between 2% to 10% of your original premium.
So if you put in $100,000 and the bonus is 5%, your account value will be $105,000. If you put in $100,000 and the bonus was 10%, your account value would start out at $110,000.
That sounds great on the surface. But don’t purchase an annuity (whether it be fixed or variable) for the bonus only. It could be a bad decision that could cost you money in the long term.
Let me explain.
If It Sounds Too Good To Be True…
What could be wrong with a “bonus?” Everyone likes to get a bonus in just about anything. Bonus means “more.” And more is always good, right?
But when it comes to an annuity bonus you need to look beyond just the bonus. Ask these questions:
- What would a comparable annuity with no bonus look like?
- What are the fees associated with this particular bonus annuity?
- Could I get an annuity with more generous benefits than the bonus annuity?
Always remember, if an insurance company gives you a bonus up front, they probably had to take away a benefit down the road.
That’s not to say that an annuity that gives you an upfront bonus is a bad thing. It just means that you shouldn’t purchase an annuity for the bonus only.
Typically, the higher the bonus the longer the surrender charge period on your annuity. Also, it will typically mean the higher the surrender charges themselves.
Also, the other benefits of your annuity may not be as generous.
For example, an upfront bonus on a fixed index annuity may mean that you have lower cap rates (i.e. lower earning potential) on your interest crediting allocations. How will this affect your growth potential? Will the upfront bonus make up for this?
Another example would be with variable annuities. If the insurance company gives you an upfront bonus on your variable annuity, are they charging higher fees for the duration of the contract? Is it worth getting a 5% upfront bonus if you had to pay an additional 0.5% in fees each year you held the variable annuity?
This is where the upfront annuity bonus can be a bit misleading. Don’t get me wrong, an annuity with an upfront bonus may be the best one for you. But you need to look at the whole picture before purchasing one.
And it is easy to be misled on products like this. Which means we need to talk about how they are typically presented to you by most financial advisors.
How The Bonus Annuity Is Typically Sold
What is the benefit to an insurance company of adding an upfront bonus to their annuities? If you think about it, they have to take away some of the back end benefits if they front load your returns.
So what’s the point?
The answer is, it presents a great selling opportunity.
If you have an existing annuity (or any financial product) that has a surrender charge, you are incentivized to hold on to it until the surrender charge period (or deferred sales charge period for some mutual funds) has passed.
If you surrender your product during the surrender charge period you will pay a penalty.
It may be in your best interest to surrender a financial product even if it does have a surrender charge that you would have to pay. It also may be in your best interest to hold on to the product. There are other factors to consider before making a decision.
But what we do know is that there is a psychological factor at play that causes us to not want to pay a surrender charge.
Financial institutions understand this as well. So what is a way to overcome this psychological barrier?
By giving you a bonus up front on your annuity purchase.
So if you have to pay a surrender charge of 3% on your current annuity or mutual fund, you could make that up with an upfront annuity bonus of 5%.
This is a great way for a financial advisor to overcome the psychological objection we all have to paying surrender charges.
- If it’s in your best interest to pay a surrender charge to get out of a current investment, then the upfront bonus has helped you overcome this psychological barrier.
- It it’s not in your best interest to get out of your current investment, then the upfront bonus could be used by an unscrupulous advisor to entice you into a bad decision.
It’s a double edged sword.
Another way the upfront annuity bonus is used to entice people to buy, is that it gives immediate gratification. You can literally look at your contract when it is delivered to you and see your starting account value as higher than what you put in to it.
You can know that your money has already given you a return. Your growth down the road may be more limited, but you can see some positive immediate results.
The Annuity Bonus Is Not Necessarily A Bad Thing
I say all this to let you know why bonuses are used. I’m not trying to beat them up. An annuity with a bonus may (or may not) be right for you.
My point is you need to consider all factors before you make a purchase.
Here are some of the drawbacks of most annuities that have an upfront bonus:
- The bigger the upfront bonus the longer the surrender charge period
- The bigger the upfront bonus the higher the surrender charge
- For variable annuities, your fees may be higher for the rest of the contract
- For fixed index annuities, your potential for growth may be lower by having lower cap rates
- Many (most) upfront bonuses will vest over time. Meaning that you may not get the full bonus if you withdraw funds early.
That’s why it’s important to look at all these factors. If you could get a comparable variable annuity with no upfront bonus, but had lower fees, you may come out better.
If you could get a comparable fixed index annuity with no upfront bonus, you may have better cap rates and a shorter surrender charge period.
If you have to take IRS required minimum distributions before your upfront bonus is fully vested, you may not get the full bonus anyway.
You need to consider these factors before you make a decision.
So those are some of the drawbacks of upfront bonus annuities. What are some of the benefits? Here are a few:
- They allow your initial balance to start out higher. Interest credited (or growth rates of sub-accounts in variable annuities), will be based on this higher initial account value, allowing it to grow to a larger amount.
- For income riders, they may start growing on this higher initial deposit amount, thus giving you a higher income potential in the future.
A holistic view must be taken before you make a purchase. Don’t buy an annuity just because if gives an upfront bonus. Look at the other factors I mentioned above.
The bonus annuity is not necessarily a bad thing. It is just a specific way an insurance company has decided to structure the benefits. Primarily, by front loading a lot of the benefits.
To front load benefits means they must have taken some benefits off the back end. Remember there are only 100 pennies in every dollar. If you get more pennies up front, then you must get less pennies on the back end.
If you have an advisor that is recommending an annuity to you with an upfront bonus, then I hope this article / video has helped. Before you make a purchasing decision, make sure you have looked at all factors involved.
And it would make sense to stress test the annuity you are considering before you purchase it. That way you can know what the fees are and how they will affect the performance of your annuity. And for fixed index annuities a stress test can help you better see how the bonus (in conjunction with the cap rates) may affect future growth.
To stress test the annuity that you are considering, just CLICK HERE and claim a spot on my calendar for a 20 minute phone conversation. I’ll help you out with this.