Annuities are life insurance contracts that are designed to produce long-term growth and eventual income payments. Returns on certain types of annuities are based on more than one interest rate, and those rates are often impacted by a variety of different factors. You must carefully review your annuity contract to determine the fees, rate indexes and the term time before you can calculate growth on your annuity.
When you buy a deferred annuity, an insurance company invests your premium payments in an investment account and your funds and earnings are converted into an income stream at a later date. Variable and indexed annuities are two types of deferred annuity products that involve two different rates of return. In contrast, fixed annuities are deferred annuity products that pay a flat rate of interest over the course of your contract. The interest rates and methods used to calculate your returns are listed on the contract that you sign at the time of purchase.
Variable annuities normally contain mutual funds, and your actual returns are based on the performance of those funds. When you cash in your annuity, you typically receive the current cash value of those underlying funds, although the insurer may in certain circumstances deduct fees and penalties from your disbursement. To calculate your returns as a percentage, you must deduct your premium payment from the current account value and then divide the dollar amount of your returns into the premium payment. Equity-indexed annuities work similarly, except that your returns are often capped at a certain percentage regardless of the actual growth in your account. Your account may grow by 30 percent, but your contract may only allow you to receive 10 percent of your earnings.
Both variable and indexed annuity contracts typically include rate guarantees that assure you of a certain level of return in the event that the account loses money. With variable annuity contracts, you typically receive the higher of your actual returns or a return of premium plus interest on your premium. Normally, your insurer pays the interest at a low fixed rate. However, you generally only have the option of receiving the guaranteed return on your money if you withdraw the funds as a series of income payments. If you cash in the account, you normally get the actual account value even if that means ending up with less cash than you originally invested.
Most indexed annuity contracts include a guaranteed rate of return in the event that your contract loses money due to losses in the underlying funds. However, rather than receiving a full return of premium plus interest, you may receive 80 or 90 percent of your premium as well as a small amount of interest paid on that sum. In many instances, your money has to grow to a certain point before you receive any returns on the positive growth. Therefore, you may receive nothing but a return of premium if your account neither drops in value nor grows beyond the specified minimum.
Aside from calculating your returns based on guaranteed interest rates and your actual account growth, you must also take fees and penalties into account. Deferred annuities begin with an accumulation phase that may last for 10 years or more. If you withdraw funds during this phase, you may have to pay a hefty penalty that can deplete both your earnings and your premium. Additionally, some contracts include clauses that mean that only the original contract owner can receive anything other than a return of premium. Therefore, your account beneficiaries may miss out on your account earnings if you pass away before you liquidate the contract.
- Stockbyte/Stockbyte/Getty Images