Is 'bonus' in your best interests?

During the past month, I have been describing some of the basics about variable annuities and how they work. This week, I'll describe the "bonus credit" feature of some variable annuity contracts.

Balancing Bonus Credits

Some insurance companies now offer variable annuity contracts with "bonus credit" features. The contracts promise to add a bonus to your contract value based on a specified percentage (typically ranging from 1 percent to 5 percent) of purchase payments.

Example: You buy a variable annuity contract that offers a bonus credit of 3 percent on each purchase payment. You make a purchase payment of $20,000. The insurance company issuing the contract adds a bonus of $600 to your account.

Variable annuities with bonus credits may carry a downside, however -- higher expenses that can outweigh the benefit of the bonus credit offered.

Frequently, insurers will charge you for bonus credits in one or more of the following ways:

* Surrender charges may be higher for a variable annuity that pays you a bonus credit than for a similar contract with no bonus credit.

* Your purchase payments may be subject to surrender charges for a longer period than they would be under a similar contract with no bonus credit.

* Higher annual mortality and expense risk charges may be deducted for a variable annuity that pays you a bonus credit. Although the difference may seem small, it can add up over time. In addition, some contracts may impose a fee specifically to pay for the bonus credit.

Is the Bonus Worth It?

Before buying a variable annuity with a bonus credit, ask yourself -- and the financial professional who is trying to sell you the contract -- whether the bonus is worth more to you than any increased charges you will pay for the bonus.

This may depend on a variety of factors, including the amount of the bonus credit and the increased charges, how long you hold your annuity contract, and the return on the underlying investments. You also need to consider the other features of the annuity to determine whether it is a good investment for you.

Example: You make purchase payments of $10,000 in Annuity A and $10,000 in Annuity B. Annuity A offers a bonus credit of 4 percent on your purchase payment, and deducts annual charges totaling 1.75 percent. Annuity B has no bonus credit and deducts annual charges totaling 1.25 percent. Let's assume that both annuities have an annual rate of return, before expenses, of 10 percent. By the 10th year, your account value in Annuity A will have grown to $22,978. But your account value in Annuity B will have grown more, to $23,136, because Annuity B deducts lower annual charges, even though it does not offer a bonus.

You should also note that a bonus might only apply to your initial premium payment, or to premium payments you make within the first year of the annuity contract. Further, under some annuity contracts, the insurer will take back all bonus payments made to you within the prior year or some other specified period if you make a withdrawal, if a death benefit is paid to your beneficiaries upon your death, or in other circumstances.

Beware of Surrender

If you already own a variable annuity and are thinking of exchanging it for a different annuity with a bonus feature, you should be careful. Even if the surrender period on your current annuity contract has expired, a new surrender period generally will begin when you exchange that contract for a new one. This means that, by exchanging your contract, you will forfeit your ability to withdraw money from your account without incurring substantial surrender charges. And as described above, the schedule of surrender charges and other fees may be higher on the variable annuity with the bonus credit than they were on the annuity that you exchanged.

Example: You currently hold a variable annuity with an account value of $20,000, which is no longer subject to surrender charges. You exchange that annuity for a new variable annuity, which pays a 4 percent bonus credit and has a surrender charge period of eight years, with surrender charges beginning at 9 percent of purchase payments in the first year. Your account value in this new variable annuity is now $20,800. During the first year you hold the new annuity, you decide to withdraw all of your account value because of an emergency. Assuming that your account value has not increased or decreased because of investment performance, you will receive $20,800 minus 9 percent of your $20,000 purchase payment, or $19,000. This is $1,000 less than you would have received if you had stayed in the original variable annuity, where you were no longer subject to surrender charges.

In short: Take a hard look at bonus credits. In some cases, the "bonus" may not be in your best interest.

Coming Next Week

Ask questions before you invest.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at [email protected]


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