Welcome to Hidden Value, the column where Joe Elsasser, CFP, addresses common financial planning issues with insights advisors and their clients may not have considered.
For the past several years, I’ve been offering free educational annuity seminars at our local public library, and inevitably the topic of bonus annuities always comes up. The concept can be confusing and the name itself is pretty misleading.
The Problem With Annuity Bonuses
Some annuity contracts offer a “bonus” between 3 and 10 percent or more. It sounds fantastic! The word “bonus” sounds like extra money, but that’s the problem — it’s not.
An annuity bonus is like a cash advance. It’s an advance against the future earnings of the contract. Any annuity that has a bonus also has a surrender schedule, and the surrender schedule penalizes the consumer for taking more money than the free withdrawal provision in any given year. The insurance company knows that they are able to advance some of the earnings that (more than likely) will be earned in the contract anyway.
Many people who buy bonus products don’t necessarily understand how the future earnings of the contract will be impacted. If they get a bonus on the front end, the future earnings will be lower. It’s not a bonus, it’s an advance on future earnings, or it’s recaptured through higher fees to the client.
A lot of carriers have a suitability rule that says you can’t replace an old product or a previously purchased product that the client already owns unless the bonus on the new product is more than a surrender charge on the old product. This leads people to believe that the bonus is free money, and it creates an excuse for insurance agents to replace products by leveraging a bonus as opposed to making an educated recommendation about the total value remaining in the current contract and whether it is greater than or less than the total value of moving to a new contract.