Rebates, longer-term financing, and other temptations are often used by automakers to get you to buy or lease a new car. But these complications obfuscate how much you really pay in financing costs. Along a similar line, fixed annuity companies frequently have incentives to reward you for investing. One of the most widely used is the “bonus rate.” But if you aren’t careful, you might not get what you bargained for. Bonus rates look good at first buy may cloud your ability to see what you really earn.
The bonus annuity rate is generally given during the first year or few years that you own the fixed annuity and can significantly enhance the initial return. Furthermore, the bonus increases the annuity’s principal on which future interest will be credited. Therefore, a bonus could possibly boost the overall yield over the contract’s term.
However, the company may be offering this reward because you are expected to keep the contract for up to 10 years. If you remove your investment before that time is up, you may be hit with surrender charges that could more than wipe out the bonus you had received. Additionally, some annuities with high bonuses may not have features that might be valuable to you, such as waiver of surrender charges for terminal illness, or nursing home confinement.
The return on your investment is certainly important, and a bonus can be a valuable addition. But don’t overlook the financial safety of the annuity company, the other benefits that annuities can offer, and how well the advisor proposing the investment understands your complete financial situation.
Since you are often locked in b y surrender charges, after the bonus period, the annuity company may drop your rate to an uncompetitive annuity rate for the remaining term. Assume this worst case and calculate your return to maturity and compare the same calculation to an annuity that does not offer a bonus rate but may offer a multi year guarantee.
Note: Bonus annuities often have higher fees and charges than annuities that do not offer a bonus. Furthermore, the surrender period is usually longer, leading to higher surrender charges.