30 Dec Bonus Annuities Explained – Are They a Trap?
Bonus annuities are a type of annuity product that offers a premium or first-year interest rate bonus when you sign a new annuity contract.
It’s an incentive provided by the insurance company to entice you to purchase their product. They are typically found with Fixed and Fixed Index Annuities.
If you’re thinking free money from an insurance company is too good to be true, you may be right.
As with most “free” offers, the devil is in the details of the contract, which is why it’s so important to understand what you’re saying YES to.
What sounds good now may not be in your best interest years down the road.
Keep reading to learn more about the types of bonus annuities, scenarios where they are offered, and the potential downsides.
Types of Bonus Annuities
If an annuity product offers a bonus for signing, then you can bet the insurance company will adjust the contract somehow so it’s profitable for the company.
This means in future years, the company may not credit interest as aggressively as they might for a non-bonus annuity product.
As with anything free, the devil is in the details. Make sure to carefully read the contract terms before signing on the dotted line.
The bonus is paid on top of all first-year premiums that you deposit into the annuity.
These are usually seen with Fixed Indexed Annuities.
For example, the insurance company offers you a 5% bonus on all premiums you deposit in the first year of your contract.
Let’s say you deposit $10,000. The company then would add a $500 bonus to your account. Then you would earn interest on your premiums deposited, as well as the bonus that was given.
Interest Rate Bonus
With annuities that offer an Interest Rate Bonus, you will usually see additional interest added for the first year of the contract.
This type of bonus is normally found in Fixed Annuities.
For example, the insurance company may add an additional 1% to your fixed rate during the first year of the annuity contract. In year two, you will see the rate drop back to a normal interest rate offered.
Common Scenarios Where You May Be Offered a Bonus Annuity
Making up for investment losses: Let’s say you are in the process of doing a 401(k) rollover, and you have $90,000 in your account.
And, in the past few years, you may have lost $10,000 due to market volatility.
So, for example, an adviser may offer to roll your funds into an Indexed IRA annuity with a 10% upfront bonus.
That would make up for most of your losses ($9,000 of the $10,000), and you could still participate in some of the upside potential of the stock market.
Replacing one annuity contract with a new annuity: Let’s say you are in year 7 of your current 10-year annuity contract, and interest rates have moved up.
You’re not happy, as you are still locked into a lower rate annuity and have surrender charges to walk away.
An adviser may offer you a new annuity that has a bonus that may offset the amount of your current surrender charges, allowing you to start earning higher rates moving forward.
The bonus would have to be higher than the current surrender charges, or many insurance companies would refuse to allow the replacement.
Increasing Lifetime Income Payments: Let’s say you just retired, and you want to turn your old 401(k) into a guaranteed monthly income stream.
Most of your 401(k) statements show you how much your account could equal in monthly payments in retirement today.
In this scenario, you could be offered a bonus annuity that would increase your payments by a certain percentage (like 7%) immediately or sometime in the future.
Potential Downsides to Bonus Annuities
“Free” almost always has a price, so don’t fool yourself into thinking the insurance company isn’t going to make sure you pay some way or another for the bonus offering.
Here are a few downsides to signing a bonus annuity contract:
#1 The Higher the Bonus, the Longer the New Surrender Charges
Just like most annuities, bonus annuities have surrender charges.
Typically, the higher the upfront bonus, the longer the insurance company wants you to stay in the product. So your contract could have much longer surrender charges.
Surrender charges penalize you for taking out more than the free withdrawal amount each year, or for surrendering the annuity before the end of its term.
These charges can be high and cost you more than you want to pay.
Again, this is why it’s critical to read the contract carefully and understand the details before you sign.
#2 The Higher the Bonus, the Lower Your Potential Earnings
The upfront bonus may lower the potential earnings of your annuity in future years. Think of it like an advance of future earnings.
Let’s say you purchased a 10-year annuity with a 6% bonus upfront from Insurance Company A.
Your $100,000 investment received an initial $6,000 upfront.
The insurance company will offset this expense with lower rates for the duration of your annuity.
Continuing with the example above, the insurance company may only give you a cap of 2% of whatever the SP500 index may earn. If you hit the 2% cap for all ten years, you would have $129,213.40 at the end of the contract.
If you had taken a different contract from Insurance Company B with no bonus, and just a 3% cap on the same SP500 index, you would have earned $134,391.16 for the same 10-year period.
#3 The Bonus May Be Vested
Many bonus annuities have what is called a vesting schedule.
Vesting gives you rights to your earned assets over time.
Let’s say your bonus annuity has a 10-year surrender period, as well as a 10-year vesting schedule.
Each year that you keep the annuity, the more of the bonus you get to keep.
This vesting schedule would only be a negative to you if you have to surrender the contract early.