What Are Bonus Annuities
Bonus annuities are fixed or variable annuities that offer the buyer a bonus rate on top of the regular return. The life insurance company that sells the bonus annuity will typically contribute an additional 2% to 10% of the first year premium, regardless of the rate of return. In other words, if the bonus annuity was purchased for $25,000 and the return is 5% ($1,250), the insurance company will add another $1,250 if the bonus is 5%. The annuity contract can be established with either a one-year bonus term or multi-year bonus terms. In most cases, the bonus is touted as a way to offset the surrender charges an annuity owner faces when he or she moves an annuity from one company to another.
Bonus Annuity Basics
Bonus annuities are a relatively new product. As the competition for investment accounts, especially retirement accounts, has grown over the past several decades, insurance and financial institutions have come up with new products to suit the needs of their customers. Over the past several years, these companies, and investors themselves, have come to realize that one size does not fit all when it comes to saving for retirement or investing for the future. Inflation, the tax code and other influences out of an investor's control make it difficult to compare the returns of one annuity product to another.
When reviewing bonus annuities, investors need to compare the cost of surrendering an annuity in order to purchase the bonus annuity, the amount of the bonus that will be paid by the insurance company and how it compares to potentially higher fees, and whether or not the he or she is vested immediately in the bonus. Regardless of being a fixed or variable annuity, a bonus annuity will still grow tax-deferred for as long as the annuitant owns it.
Moving an Annuity from One Company to Another
When an annuitant moves a deferred annuity from one company to another, he or she cannot receive the money directly. Unlike rolling over another tax-qualified account, for which the account owner has 60 days to deposit the money in another tax-qualified account, an annuity exchange must take place between the two insurance companies. This is known as a 1035 exchange. When a 1035 exchange is done correctly, the annuity owner does not owe taxes, as he or she has not taken possession of the money.
The bonus payments on bonus annuities make the exchange look attractive, especially if the annuity owner has owned the initial annuity long enough to avoid any surrender charges. Annuity owners interested in a 1035 exchange should always make sure that the annuity surrender charges would not be more than the bonus paid on the new annuity. Bonus annuities often have higher annual fees and expenses than traditional annuities.
What Fees Are Assessed on a Bonus Annuity?
Sometimes, the bonus that is paid on the annuity is less than the extra fees that are charged. For example, if an annuitant transferred a $500,000 annuity from one company to another and was given a bonus payment of five percent ($25,000), he or she would have an annuity worth $525,000. If the fees charged on the old annuity were 1.3 percent and the fees on the new annuity are 1.8 percent, it won't take long before the increase in fees exceeds the amount of the initial bonus.
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Why Choose a Bonus Annuity?
Investors who have lost money on previous investments, especially retirement investments, often turn to bonus annuities to make up some of what they've lost. However, in order to offset a portion of the bonus amount that they pay, some insurance companies reduce other benefits often associated with annuities. For example, the death benefit may be smaller or not available. In some cases, the bonus payment may be tied to a vesting schedule. The annuitant may have to hold on to the annuity for one, five, 10 or more years in order to have access to the entire bonus amount.
For these reasons, bonus annuities are not often suited for all annuitants. Even if a traditional variable annuity is right for an individual, a variable bonus annuity may not be. While most insurance companies will allow a bonus annuity owner to withdraw up to 15% of the value of the premium payment each year, this is best done after age 59 ½ so that federal tax penalties will not apply.
Surrender periods can also be longer for bonus annuities. Whereas more traditional variable annuities may have a surrender period of six years, a variable bonus annuity may have a surrender period of seven years. This longer time frame allows for the insurance company to collect the increased fees, which offsets the bonus it paid when the annuitant purchased the annuity. Only those investors with significant other assets should consider bonus annuities.
Additional Features of Bonus Annuities
While some insurance companies reduce the number of benefits associated with bonus annuities, others do not. Features such as long-term care riders that pay for future home-health care services and guaranteed income riders that guarantee a minimum income payment can be added to bonus annuities. These features can be expensive, however, and investors are always advised to compare policies and riders among different providers.
It's important to remember that the value of a variable bonus annuity will fluctuate with market conditions, as the variable portion of the annuity still functions like a traditional variable annuity. If an investor is concerned about fluctuating income, he or she should consider a guaranteed income rider or a fixed annuity. The income paid on a fixed annuity is the same each year, regardless of what happens in the stock, bond or credit markets. Before purchasing a variable annuity, an investor should always make sure that he or she has additional income sources to offset any reduction in income. He or she should also make sure that the proper asset mix has been chosen based on the balance of his or her portfolio and risk tolerance.
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