How a Fixed Annuity Works, and What the Rate Actually Guarantees

A fixed annuity is a contract with an insurance company: you hand over a sum, the company credits interest at a rate it declares, and you agree to leave the money alone for a set number of years. If you take it out early, you pay a surrender charge. That is the whole shape of the product, and almost every question worth asking is about the two numbers inside it — the rate and the surrender schedule.

There are two rates, and they are not the same promise

Every fixed annuity has a current rate and a guaranteed minimum rate, and the difference between them is the difference between what you are being shown and what you are actually promised.

The National Association of Insurance Commissioners describes the guaranteed minimum as a rate the company sets that “cannot change for the life of the contract,” while the current rate is set by the insurer, held for a period that is typically one year, and may change when that period ends.

A multi-year guaranteed annuity, sometimes called a MYGA, closes that gap on purpose: the current rate is locked for the whole term rather than one year at a time. If the term of the rate and the term of the surrender charge are the same number of years, you know exactly what you have. If the rate is guaranteed for three years and the surrender charge runs seven, you have a three-year promise attached to a seven-year commitment, and you should know that before you sign rather than in year four.

Ask how long the current rate is guaranteed, in years.
Ask how long the surrender charge runs, in years.
If those two numbers differ, ask what happens in the gap.

The surrender charge is the real term of the contract

A surrender charge is what the company keeps if you take money out during a set period after you buy. The NAIC guide puts it plainly: it is “a charge if you take part or all of the money out of your annuity during a set period of time,” and the percentage usually steps down each year until the period ends.

Most contracts also allow a free withdrawal — commonly around 10% of the value each year — that you can take without triggering the charge. That allowance is what makes the difference between money you cannot touch and money you can draw on modestly while the rest keeps its rate.

Some contracts add a market value adjustment on top. An MVA moves your withdrawal value up or down with interest rates: as the NAIC explains, if rates are lower when you withdraw than when you bought, the adjustment “could increase the amount you could take from your annuity.” It can also cut the other way when rates have risen.

What a premium bonus costs you

Some annuities credit a lump sum up front, called a premium bonus. The NAIC guide is direct about the trade: “You may not be able to withdraw some or all of your premium bonus for a set period of time.” A bonus is generally paid for somewhere else in the contract — a lower ongoing rate, a longer surrender period, or both. It is not free money, and comparing two contracts on the bonus alone will usually pick the worse one.

Who a fixed annuity tends to suit

It suits money that has a job and a date: a sum you will not need for the length of the surrender period, that you want to grow at a known rate rather than a hoped-for one, and that you would rather not watch move. It suits someone who already has liquid savings elsewhere for the unexpected.

It suits you less well if the money is your emergency fund, if you expect to need more than the free-withdrawal allowance in any year of the surrender period, or if you would be putting in so much that the rest of your savings could not absorb a surprise.

What to check before you sign

The current rate, and exactly how many years it is guaranteed.
The guaranteed minimum rate — the floor you actually own.
The surrender charge percentage for each year of the schedule.
The free withdrawal allowance, and whether it starts in year one.
Whether a market value adjustment applies.
Whether any bonus is subject to its own vesting schedule.
The free-look period. The NAIC notes most states give a window, commonly 10 to 30 days, to return the contract.

If you are working out whether an annuity has a job to do in your plan at all, the retirement income gap calculator is a more useful starting point than a rate sheet: it shows whether the income already arriving covers what you need, and how large a shortfall you are actually solving for.

Lifeworth Insurance Agency is an independent insurance agency. This article is general information, not tax, legal or investment advice, and it does not recommend a product. Annuity guarantees are backed by the claims-paying ability of the issuing insurance company. They are not bank deposits and are not insured by the FDIC. Product features, rates and availability vary by company and by state. Read the contract and the disclosure statement before you buy.

Sources

NAIC — Buyer’s Guide to Fixed Deferred Annuities

Disclosures. This article is general information about annuities. It is not financial, tax, legal or investment advice and is not a recommendation to purchase, keep, surrender or replace any annuity. Annuity guarantees are obligations of the issuing insurer and depend on its financial strength and claims-paying ability; annuities are not bank products and are not FDIC-insured. Lifeworth Insurance Agency is a trade name of Lifeworth Financial Group LLC, National Producer Number 21228343, licensed in Florida.