by David Swanson
A type of annuity offered by insurance companies, a bonus annuity is a financial product that provides a bonus, often between 1% and 10% of your initial investment. This “free money” may significantly increase the value of your annuity from the get-go. By including a bonus, these safe money products give your principal investment an immediate boost. However, in return for getting this boost, there are usually some trade-offs involved. When you purchase a bonus annuity, you might have to agree to potential limitations on growth, more significant surrender charges, or reduced future payouts.
Bonus annuities come in two main types: fixed annuities and fixed indexed annuities (FIAs). Fixed annuities provide a set interest rate, and some include an upfront bonus for the first year. Fixed-indexed annuities are slightly different. In a FIA, your returns link to the performance of a market index like the S&P 500. FIAs are attractive to some retirees because of their potential for higher gains during good market years and protection from losses during downturns. The bonus in both types of annuities is normally credited to the initial premium, boosting the annuity’s initial value.
A few pros of bonus annuities
While it is always wise to consider potential long-term consequences when making any financial decision, there are a few specific situations where a bonus annuity might make sense.
These include:
- You want to enhance your annuity’s value immediately: The primary advantage of a bonus annuity is that it immediately increases your balance. For example, if you invest $100,000 in a bonus annuity with a 5% bonus, the insurer adds an extra $5,000, bringing your starting balance to $105,000. Depending on your unique circumstances, this immediate boost can be beneficial.
- You want the potential for more income: For those seeking guaranteed income in retirement, a bonus can increase the annuity’s value. Boosting your account value helps you generate a higher payout over time. If you use your bonus to fund an income rider, this could lead to a more significant guaranteed lifetime income. Even a slight boost in income can play a role in ensuring a more successful retirement outcome.
- You like the idea of tax-deferred growth: Funds in a bonus annuity grow tax-deferred until you make withdrawals, providing an advantage over taxable investment accounts.
- You want to leave a legacy: Bonus annuities can be helpful in estate planning, as they can potentially increase the death benefit payable to your beneficiaries. Having a bonus annuity helps you provide financial security for loved ones when you pass away.
Bonus annuities some cons, though.
- You may get lower returns in the future. To be sure, an initial cash bonus is appealing. However, this feature often comes at the cost of lower potential returns in subsequent years. For example, in a fixed-indexed annuity, the bonus might reduce the participation rate for index-linked growth. This reduction means you could miss out on some of the upside potential that would have been available in a non-bonus annuity.
- Bonus annuities can have higher fees: Bonus annuities can carry higher expenses, including administrative costs or charges related to the bonus itself. Fees tend to erode the long-term growth of an annuity. Such an erosion means the bonus could be less valuable than it appears at first glance.
- You could have a longer surrender period: Some bonus annuities come with extended surrender periods—sometimes up to 10 years or more. If you have to access your funds before the end of this period, you could face hefty surrender charges. Surrender charges have the potential to negate any benefits you get from the initial bonus.
- You may have a vesting schedule: Many bonus annuities have vesting schedules. A vesting requirement means you must keep your funds in the annuity for a set number of years before you get your entire bonus. If you withdraw your funds too early, you may forfeit some or all of the bonus money. A vesting schedule could render your bonus annuity less flexible if you need access to your money sooner than expected.
- Sometimes, bonus annuities are sold incorrectly. Bonus annuities can indeed be powerful products for certain people. However, salespeople and companies may market them with a focus on the idea of getting “free” money. Often, marketers fail to explain these complex products or discuss possible downsides thoroughly. There may be a lot of “catches” attached to a bonus product. For example, some companies offer what’s known as a “phantom bonus,” which increases the value of an income rider or death benefit rather than your cash balance. Advertising makes these products sound appealing, but they can come with lower payout rates, caps, or higher fees that will override any benefits you could get from the bonus.
Let’s look at a hypothetical situation
Imagine you invest $200,000 in a fixed-indexed annuity offering a 5% bonus. The insurer adds $10,000 upfront, increasing your account value to $210,000. However, over the next several years, the annuity may have a lower participation rate (say, 60% of the index’s return) compared to a non-bonus annuity, where you might receive 80%. Additionally, the contract could come with higher fees or a more extended surrender period, meaning it could take several years before you fully realize the benefits of the bonus.
Conclusion
Bonus annuities can offer attractive benefits, such as immediate value additions and enhanced income potential, but they come with trade-offs. Whether they’re the right choice for you depends on your financial goals, time horizon, and willingness to accept certain limitations. Always ensure you fully understand the terms, including surrender charges, vesting schedules, and long-term growth potential, before committing to a bonus annuity.
If you are someone who wants or needs immediate value added to your annuity and are comfortable with potential limitations on future returns, you should discover more about bonus annuities. You may also benefit from a bonus annuity if you’re seeking increased guaranteed lifetime income since a bonus might enhance your income rider’s payout amount.
A bonus annuity can also be useful if you have specific estate planning goals and want to increase the death benefit for beneficiaries.
However, if you plan to access the funds early or are seeking high returns without limitations, a bonus annuity may not be the best choice. It’s crucial to weigh possible pros against potential drawbacks and, ideally, consult with a financial advisor who specializes in annuities to ensure this option aligns with your overall investment strategy and retirement goals.
Contact David now for a no-cost, no baloney evaluation of your current retirement plan. He’ll spot any gaps and make suggestions so you’ll have what you need to rock your retirement.
