What You Need to Know About 8 Percent Annuity Return Decision

With the growing uncertainty in the market, safe investments for retirement are becoming more attractive each day. This is because when you know you have a fixed income through your investments, issues such as stock market volatility or outliving your savings are less worrisome. One such popular source of reliable income during retirement is an annuity. Annuities are pension-like products that offer consistent payouts. Thus, annuities have always been an attractive option for retirees. Also, with a low-interest rate on savings accounts and fixed deposits, annuities become a dependable source of income and growth. In many cases, a salesperson would promise an 8% annuity return to lure you. However, it is important to understand the specifics involved before you buy one for your future.

Is it possible to earn an 8% return on an annuity?

Often, online annuity promotion ads hard-sell their products by offering an 8% return. However, in reality, the ads are only misleading but not completely false. The truth is, some annuities can assure an 8% rate but only under specific conditions. The ‘8%’ is not your annuity’s return but is the growth percentage of an income account value, which is created by an additional rider.

Realistically, you would not be able to withdraw the 8% return. By purchasing a lifetime income rider along with your annuity, you would only be able to increase the income account value at a specific rate of 4-8% annually. This value, in turn, determines the future lifetime income payouts. This method is also known as a guaranteed roll-up calculation. Additionally, insurers charge a specific fee, mostly 1% of the annuity value, for providing this rider.

For example, you buy an indexed annuity because the salesman promised you a certain return of 8%. But this 8% return is not specific to the growth of your funds. Instead, this percentage will be used as a roll-up formula for future income growth. You would not be able to withdraw the monetary equivalent of this growth percentage as lump sum ever. However, this return percentage will be used to determine your lifetime future income.

How much do you actually earn on an annuity?

Typically, in an annuity, you would earn interest depending on the lock-in period and credit rating of the issuer. According to AnnuityAdvantage’s online rate database 2019, the average rate for a 10-year annuity is 4.3%, for a five-year annuity is 4.1%, and for a three-year annuity is 3.1%. These rates are secure rates that would allow your savings to build safely. However, in this scenario, an 8% interest rate has a different perspective.

The 8% interest is accumulated via income riders and roll-up rates. Riders can be classified as specific add-ons that customize a general annuity to suit your needs. Some of the common riders include a death benefit, unemployment, disability, etc. Each rider has its fees and conditions.

When you add an income rider to a deferred annuity, you can secure a reliable income source for your lifetime. These income riders grow a given rate, which compounds in the deferral years. The income rider percentage is also known as a roll-up rate. This roll-up earning accrues only till the time you are deferring.

You can consider this from a different perspective. When you buy an income rider, you create a ‘Phantom’ account for your annuity. So, there are two separate sections. One, where your annuity principal grows at a rate of say 3%, and two where your principal is added to the 8% roll-up earnings. You can never make a lump sum withdrawal from this ‘Phantom’ account, nor are these earnings paid to your beneficiaries after your death. In all, these riders only offer a lifetime income promise.

The annuity issuer will use the ‘Phantom’ account to determine your lifetime monthly payments. So, as long as the annuity is deferred, your ‘Phantom’ funds will grow at 8% interest.

Is there a catch on the advertised ‘8%’ return on an annuity?

Now the obvious question is that if the funds were growing at 8% interest, the ‘Phantom’ savings should be more than the actual account accumulation. This is only true on paper. Behind the 8% growth, there is a concept known as Guaranteed Withdrawal Percentage. A Guaranteed Withdrawal Percentage is an age-based limitation on your annual withdrawals.

When you start to make withdrawals, the issuer multiplies your benefit base with the definite withdrawal rate to determine the earnings you finally receive. This is the lifetime income during retirement if you purchase an annuity that promises an 8% return.

So, overall, by using the ‘Phantom’ account as both a benefit base and withdrawal percentage, your issuer would be able to offset the promised high return of 8% by restricting the amount you would receive annually. Moreover, because you are never given the possession of the ‘Phantom’ account or any access to its funds, you cannot simply enjoy the high interest and invest elsewhere. The real worth of your annuity and the return is the value of your actual annuity account because, in the real world, the roll-up rate does not have worth.

Should one buy an 8% annuity?

There is no definite answer to whether you should invest in an 8% annuity or not. The important point is to be aware of its calculations and implications to avoid setting false hopes. That said, the income riders for annuities would be a good fit for some people. There are specific circumstances and financial goals for which an income rider or a roll-up rate could contribute significantly.

In comparison to bank cash deposits (CDs), multi-year annuities with income riders that promise an 8% return are a better choice. These riders often provide higher returns than CDs. Moreover, the interest in annuities is tax-deferred, unlike CDs. Also, in the case of fixed-index annuities, income riders act as an additional layer of protection that offers a lifetime income guarantee. By combining an income rider with a fixed annuity, you can earn well from the sharp rise of the stock market, safeguard your principal, while also earn a lifetime income assurance.

In case, the idea of an income rider is not in-line with your financial goals, you can also use a deferred income annuity or annuitize a fixed annuity upon retirement for the security of future income.

To sum it up

Overall, the 8% return pledge on an annuity is not as simple as it sounds. But that doesn’t diminish the fact that these riders can be a great source of lifetime reliable income. It is important for you to be aware of its in-depth calculation and implications on your savings, and then accordingly make your decision. Moreover, since annuities are available in different types and variants, and income riders also vary significantly from one issuer to another, it is critical for you to conduct thorough research, understand the terms wisely, and make comparisons before finalizing on one. For the best advice on annuities and their inclusion in your retirement income, you can seek guidance from professional financial experts.