Bonus Annuity – How Does It Work?
A bonus annuity is an annuity product that offers either an upfront bonus on premium or a first-year bonus on the interest rate. The premium bonuses are usually associated with fixed index annuities, while the interest rate bonus usually comes with a traditional fixed annuity. Bonuses are even attached to variable annuities on occasion.
Life insurance companies offer the bonus as an incentive to choose that annuity. One of the complexities of annuity bonuses is that, while they usually get credited on day 1, they actually vest over the contract’s life.
It’s good to know that generally speaking, the growth potential of a bonus annuity will be less than that of a non-bonus annuity. This is one trade-off for the annuity bonus.
Here’s a rundown of how bonus annuities work. This is a good starting point of what to look out for if you are considering a bonus annuity for your financial goals.
How Does the Annuity Bonus Work?
Annuity bonuses work by giving the annuity owner extra money, either at the start of the contract or in the future. This extra amount is over and above what the premium paid would usually buy.
For example, if you start with $100,000 in your bonus annuity, you might be given another $5,000 by the insurance company.
The idea of the bonus is to encourage policyholders to keep their money in the annuity for longer. Also, by offering the bonus, the issuer might be able to offer a higher total payout than would be available on other annuities.
If your bonus is a higher interest payment, the annuity issuer will add interest on top of what your annuity offered. For example, if your annuity offers 5 percent and your insurance company offers a bonus of 10 percent, the company will add the extra 5 percent to make a total of 10 percent.
The agreement may apply only to the first year or can be a multi-year bonus. The seller will often describe this extra interest as offsetting any surrender charge you may incur.
Quick Word on Surrendering One Annuity for a Bonus Annuity
What about when you already have an annuity and you are thinking about swapping it for another?
When considering a bonus annuity, compare the cost of surrendering an existing annuity to acquire the bonus annuity, along with the amount of the bonuses, how it compares on fees, and your vesting schedule.
Your financial professional can help you decide when the answers support when a bonus annuity might make sense for you.
When Should You Consider a Bonus Annuity?
Various conditions may lead you to opt for a bonus annuity.
A bonus annuity is an excellent option to consider when you surrender an annuity still in its surrender period (maturity period). The bonus can often help you recoup the money lost, if any, to a surrender charge.
Bonus annuities are also helpful when you need or want upfront growth on your money rather than a higher interest rate long-term.
Of course, you will usually earn on that bonus, but most of the time, it won’t vest immediately. In fact, the bonus may not vest 100% until your surrender period on the bonus annuity is over.
Finally, it’s essential to understand that you should never buy an annuity just for the bonus. Instead, you should work with your financial professional to find the annuity that best fulfills the goals and objectives you have for your annuity.
Then, if there is an annuity in the group that you are exploring and it offers a bonus, you can grab it. In other words, a bonus should function as just a little something extra, not as your primary reason for choosing that specific product.
If you have found a new annuity that is enormously better than what you have, you can use a bonus to cover the surrender charges of the existing annuity. Remember that you should only do this when the bonus will cover the surrender charges, and the new annuity offers a huge improvement over the one you already have.
Benefits of a Bonus Annuity
Several benefits can come from owning a bonus annuity. Let’s look at them separately.
Higher Guaranteed Growth
Assuming you meet all the requirements for your bonus and vest, you will see growth that is guaranteed for your money. Note, however, you might be giving up higher growth potential that a non-bonus annuity might otherwise present to you.
Bonus annuities often give contract holders increased flexibility with ongoing access to their annuity money if needed. You may be able to withdraw a certain amount annually without paying a surrender penalty, for example.
Another way to use a bonus is where you are purchasing an annuity with an income rider and plan to take income in the first few years. The bonus in your new annuity can help boost your remaining payments.
Knowledge That You Have the Annuity Bonus Coming
Knowing that the bonus will be available if you stay in your annuity can also be helpful.
When your surrender period ends, and that bonus is vested, it will increase the assets available for being moved into another annuity or for starting to receive annuity payouts.
Either way, your retirement money will have grown.
Bonus Can Be Used to Offset Surrender Charge
What if you have a reason to replace your current annuity and it’s still in its surrender period? Then you can use the bonus to offset the costs of the surrender charges you must pay to make the desired change.
For example, say that you are in an annuity product that no longer meets your needs or risk tolerance, and you are still in a surrender period. You may be able to use the bonus from a new annuity to offset the costs of surrendering the old annuity.
Reducing Your Out-of-Pocket Expense
Sometimes you may want to purchase an annuity but use as little money as possible for the purchase. The bonus can help meet the limited goal of the annuity a little more effectively.
It’s best described, however, as gaining a certain level of certainty in how much you can do initially by giving up earning potential on the backend.
Drawbacks of a Bonus Annuity
As with every financial product, annuities have advantages and disadvantages. Some of the latter include:
The primary downside to a bonus annuity is the limitation on the upside potential. In other words, you will have sacrificed some portion of your potential growth to get the bonus.
For example, a bonus annuity often has a more extended surrender period and a higher surrender charge than a non-bonus annuity. That applies in particular if the bonus annuity doesn’t vest immediately.
Fewer Riders and Benefits
Sometimes, in order to pay for the cost of a bonus, the life insurer will cut back on some of the other benefits you might find in another annuity. Often this is a rider benefit, such as an income rider.
Again, it’s crucial to understand all of the features and costs of your bonus annuity before you commit to a decision.
Longer Surrender Periods
Likewise, surrender periods – which certainly start over when you purchase the new annuity – may be more extended than you might be used to facing.
Make sure that if you are leaving a short-term remainder of a surrender period to enter a much longer surrender, the bonus you receive is worth it for the extended lock-up.
Virtually all annuities lock up your money, to a large extent, for some period. Bonus annuities tend to have a longer time than others.
Usually, to get a bonus, you must be willing to accept a seven-year surrender period or longer (though this isn’t always the case).
Extended Vesting Schedule
Also, of course, if you leave before your bonus is 100% vested, you will leave a large portion of it behind. That can be sticky if you also have to pay a surrender charge.
Further, as we have covered prior, you may not even own your bonus until years after you started the annuity. Many annuity bonuses don’t vest completely until the annuity contract has matured.
Finally, expenses are often higher on a bonus annuity, making your actual gain from the bonus possibly even less.
Bonus annuities often start at a lower rate of growth before they add the bonus. In other words, the bonus isn’t as much as it appears to be because you started lower than you would have without the bonus.
Look for your net gain, not just the gross amount of the bonus.
Some Final Thoughts on Bonus Annuities
One way to look at an annuity bonus is as a pre-payment of the full contractually promised money that you would otherwise receive on your annuity.
By law, and to stay competitive, life insurance companies must calculate the profitability of any product that they sell. They have a department of actuaries making those calculations on products throughout the design process.
A bonus annuity isn’t so much a play in that it gives you more money. Rather, it’s moreso that it gives you what you would expect, but in a different way.
Keep these rules of thumb in mind as you explore bonus annuities, and different annuities in general. Your financial professional can help you save time by finding options that are right for you, answering your questions, and assisting you in making well-informed choices.
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