The Truth About 8% Annuity Returns

There is a lot of marketing done that references various “returns”. Much of it is misleading at best and flat out incorrect at worst. Let’s try to make sense to all the rhetoric.

Marketing, typically, is designed to generate interest in people that may be in the market for a product or service. It should capture interest by emphasizing the best attributes of the product or service. But, I am sure most would agree that, in many cases, it goes way beyond that.

Have you ever seen a car lease add that screams out the monthly payment, but “forgets”, to mention how much down payment is necessary to get that payment? There are many examples of that in the marketing world every day, but in the Financial Service business, there is no room for it.

The advertisements that discuss “returns”, should always clarify what they are referring to. But usually, they do not. There are considerable differences between return on cash, and income yield. Here are some very important ones:

Most importantly, someone considering one of these types of annuity contracts needs to understand, that they typically have two separate accounts; the “income account”, and the “cash, or market account”.

The Income Account

The income account is just an accounting ledger that accumulates money from your original deposit, an initial bonus (not given on all products), and a “roll up” rate. This is the percentage that the ledger grows by policy contract year. It could be a simple rate, or a compounded rate. The 8%, referred to in the article heading, is an example of a “roll up” rate. After a period of years of accumulating money in this account, the accumulated amount in the ledger is then multiplied by the “distribution rate”, which is typically determined by the annuitant’s age, or the annuitant and their spouse (if wanting a joint payout – contractual income over two lives). In some cases, it may also be used to determine a Death Benefit, but very rarely used for lump sum purposes. This is not a “cash” account, and should not be viewed as such.

The income account is used for determining “guaranteed* income” amounts, not for determining how much cash you have. It is very valuable because it determines your guaranteed income amount, usually, for a lifetime. The rates that are advertised, and that many agents use to describe these products are typically tied to this account. They are “real”, but are used for income determination ONLY, not for cash value determination. Further, the highly touted “roll up” rates are just one of the several factors that will be applied together to determine your lifetime income amount, so these annuity marketers focusing on just the “roll up” rate is exactly like a car dealer touting a low monthly rate to own/lease a car without mentioning the duration of payments… hollow rhetoric.

The Market Account (aka – “Cash” Account)

The market or “cash” account, is the actual amount of cash you have in your contract. This account is usually subject to a surrender charge schedule, and typically allows for “up to 10% withdrawal a year” without surrender charges applied. These surrender charge schedules could be as long as 18 years, but are usually 10 years or less.  This account grows on the basis of a formula the contract has, that is tied to a market index. Often, the S&P 500 Index is one of the formula options you would have to choose from, although some products use multiple other market indexes as well.  Also, if you wanted to cancel the contract, the insurance company would use this account (subject to surrender charge schedule) to determine how much cash you have available to receive.

The market account and the income account are separate ledgers. Occasionally, they can crossover through a “step up provision”, but that is a discussion for another article.

The 8% rates advertised are accurate in relating to guaranteed income, but they should not be misconstrued to mean cash accumulation because they typically refer only to the Income Account. These rates are real, and have legitimate value, but the buyer must understand the difference between the two different accounts.

With full disclosure, I am an advocate of guaranteed* income riders, and feel they provide a extremely important benefit, guaranteed lifetime income. This is very valuable, but the buyer must know how their INCOME will truly be determined, and that THE TWO ACCOUNTS ARE DIFFERENT AND SEPARATE.

Don’t be misled by unclear advertising.  The real story here is that these riders can be very useful in retirement. But be careful, it is extremely important to know what they do, and what they don’t do!

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