Declared rates and non-guaranteed elements in annuity contracts

When people say an annuity is "guaranteed," they usually mean one thing: the insurer promises certain minimums. Almost every annuity also contains terms the insurer is allowed to change after you buy. The marketing page tends to feature the guaranteed minimum or the current best number, and the contract describes both in the same dense language. This checklist is meant to help you sort every term in a contract into one of two piles, so that you know which numbers you can plan around and which you cannot.

The examples use round numbers made up for the illustration. They are not any company's terms and they are not predictions of where rates will go.

How to sort a term

Read each term in the contract and ask three questions.

1. Is it guaranteed, and for how long? A term can be fixed for the life of the contract, fixed for a stated period such as the first three years, or declared again at each renewal.
2. If it can change, what stops it from changing to nothing? Look for a stated minimum or maximum in the contract. A cap that can be reset "at the insurer's discretion" with a stated minimum of 1% is very different from one with no minimum.
3. What notice do you get, and what can you do about it? Some contracts promise advance notice of a change and allow a penalty-free exit window afterward. Many do not. Do not assume a protection that the contract does not state.

Words that signal a changeable term include "current," "declared," "initial," "may be changed," "at the company's discretion" and "renewal." Words that signal a fixed term include "guaranteed," "for the term of the contract" and a number followed by a date range. When a term uses both, as in "guaranteed minimum of 1%, current rate of 4.5%," the number that matters for planning is the first one, and the number that matters for comparing offers is the second.

The general idea has a name in the industry: non-guaranteed elements are the parts of a contract the insurer can adjust, as against the guaranteed values, which it must honor. Annuities have both, and the line between them is not always where the brochure puts it.

Group 1: The interest you earn

Initial rate and rate guarantee period. In a fixed annuity or a multi-year guaranteed annuity, the first rate is usually guaranteed for a stated number of years. This is the number advertised. Check the exact length and whether it applies to your premium only or also to later deposits.

Renewal rate. When the guarantee period ends, a fixed annuity credits a new rate the insurer declares. This is the most important changeable term in a fixed contract. It is often set with reference to market conditions and the insurer's investment returns, as the guide to how annuity rates are set and why they move explains, and it can be much lower than the initial rate. Reason to check: the first three years may be the best years.

Minimum guaranteed rate. The contract also states a floor below which the credited rate cannot fall, and that floor is often well below the initial rate. Reason to check: this is the real guarantee, and it determines the worst case you are signing up for.

Bonus credits. If the contract adds a premium bonus, find out whether it vests over time and whether it is recaptured on early exit. A bonus is a known value only if you stay long enough to keep it.

Here is why the renewal rate matters in dollars. Say $100,000 is guaranteed 4.5% a year for three years. The arithmetic is $100,000 times 1.045, three times over, which gives $114,116.61 at the end of year three. In year four, the insurer declares a renewal rate of 3%, so the balance grows to $117,540.11. If the rate had stayed at 4.5%, year four would have ended at $119,251.86. The renewal decision cost $1,711.75 in a single year, and it compounds in later years. Nothing improper happened: the contract allowed it. What matters is whether you understood it when you signed.

Group 2: Indexed credits

In an indexed annuity the credit comes from a formula, and almost every ingredient of the formula can be a changeable term. The guide to fixed indexed annuities: caps, participation rates and trade-offs explains each, and the worksheet post on working out a credit by hand shows the arithmetic.

Cap rate. The most the strategy can credit in a period, however high the index goes. Check whether the cap is guaranteed for the contract life, guaranteed for one period, or declared fresh at the start of each period. Ask for the minimum cap in writing.

Participation rate. The share of the index's gain that you receive. A participation rate of 80% on a 10% gain credits 8%. The same questions apply: how often can it be reset, and is there a minimum?

Spread, margin or asset fee. A deduction taken from the index gain before crediting. A spread of 2% on a 10% gain credits 8%. If the index gain is less than the spread, the credit is zero, not negative.

Floor. The lowest credit in a period, often zero in a fixed indexed annuity. A zero floor means you do not lose to the index, but it does not mean you gain every year.

Strategy availability and index substitution. The contract may let the insurer drop an index or replace it with another. Reason to check: if your favored strategy is retired, your cap and participation will be those of the replacement.

Crediting period and dates. Annual, two-year, six-year; and the anniversary date that fixes when the index is measured. Money taken out before the end of a crediting period often forfeits the credit for that period.

To see how much a reset matters, take a $100,000 balance and an index gain of 10%, then compare the insurer's current terms with a reset:

In a modest year the effect differs by design. If the index gains only 4%, the cap design credits $4,000 under both the current and reset terms, because 4% is below either cap. The participation design credits $3,200 now and $2,400 after the reset. The spread design credits $2,000 now and nothing after the reset, because the 4% spread absorbs the whole gain. Which kind of term you hold decides how a reset feels.

Group 3: Charges and fees

Rider fee, current and maximum. Contracts often show a current rider fee and a higher maximum the insurer may charge. Reason to check: the fee in your illustration may be the current one, and the maximum is the worst case. The guide to annuity fees, explained lists typical layers.

Administrative or contract fee. A flat dollar charge, which can be waived above a certain balance. Check whether the dollar amount can rise.

Mortality and expense charge and fund expenses (variable contracts). The percentage charges and the investment costs in each fund. The prospectus lists the current expense ratios, and they can change with the fund even when the contract's own charges do not.

Premium taxes. In some states the insurer deducts a premium tax. Whether this is taken up front or at annuitization depends on the contract and the state.

Reason to check all of these: fees are a changeable term most people never revisit, and they are charged every year.

Group 4: Rider mechanics

Roll-up rate and how long it lasts. If the benefit base grows at a stated percentage during deferral, find out the percentage, the number of years it applies and whether it is simple or compound. The roll-up is a formula for the benefit base, not a return on your money. The post on benefit base versus account value explains the difference.

Withdrawal percentages by age. The table of percentages that apply at the age you start withdrawals. Check whether the table is fixed at purchase or the insurer can offer a different one to new buyers only.

Step-up rules. Whether and when the base is raised to the account value. Check the dates and whether a step-up also raises the fee.

Investment restrictions. Many riders require that you hold certain funds or strategies, and the list can change. If the list is cut, you may be forced to move money.

Group 5: Exit terms

Surrender charge schedule. Usually guaranteed once the contract is issued, which is one of the few terms that is, but check, as described in annuity surrender charges and free withdrawals.

Free withdrawal percentage and its base. Whether it applies to the beginning value or premiums, and whether it carries forward.

Market value adjustment formula. The reference rates, the formula and any floor. The explainer on market value adjustments covers how it works. A market value adjustment is a changeable term if the reference index is tied to current rates; the contract should state the formula and the floor.

Group 6: Payout and death benefit

Annuity purchase rates. If the contract lets you convert the account to an income stream, it usually states guaranteed minimum factors and also current factors. The guaranteed factors are the worst case.

Death benefit formula. Whether it is the account value, a return of premium or an enhanced amount, and whether the enhancement stops at some age.

Why insurers keep terms changeable

It helps to understand the reason behind the design, because it tells you which changes are routine and which deserve a question. An insurer that promises an interest rate or an index formula invests your premium, mostly in bonds, and earns a spread between what it earns and what it credits. If market yields fall after you buy, a fixed promise for many years would squeeze that spread; if they rise, the insurer wants to keep competitive terms for new money. Changeable terms let the company adjust, and in exchange it usually gives a higher initial number than a fully guaranteed product could.

That trade has a fair side and a hard side. The fair side is that a changeable term is what lets the insurer offer a competitive first-period number at all. The hard side is that the buyer carries the risk of unfavorable resets, and the buyer is rarely the one who read the clause. Regulators and the NAIC set the framework for how insurers describe these terms and what minimum values a contract must carry, and the state insurance department is the place to ask about your own state's rules. Neither side of the trade is a reason to avoid an annuity. It is a reason to read the clause before the contract arrives, not after.

Three ways people misread these terms

1. Treating the illustration as the contract. An illustration or brochure may show the current cap or an assumed average, and the page often says that those figures are not guaranteed. The contract controls. If the illustration and the contract disagree, you have found the question to ask before the free-look window closes.
2. Counting the first-period rate as the long-run rate. A fixed annuity advertised at a high initial rate for three years can be a fine product if you plan to exit at the end of year three without a charge. It is a different product if the surrender period lasts seven years and years four to seven earn the renewal rate.
3. Confusing a floor with a guarantee of growth. A zero floor on an indexed strategy means a down index year credits nothing. It does not mean any given year credits something, and a long run of flat years with fees still being charged can leave the account value flat or lower.

What the contract says about changes

Whatever the term, look for the section on changes and read these points:

1. How often can the term change: at each crediting period, yearly, anytime?
2. Does the contract state a minimum or maximum for it?
3. Does it promise notice, and how many days before the change takes effect?
4. If you dislike the change, can you leave without a surrender charge for a window?
5. Does a change apply to existing contracts, or only to new ones?

If the contract is silent on any of these, ask the insurer in writing and keep the reply. State insurance departments regulate how insurers describe and change annuity terms, and a complaint to the department is available if you believe a change was not made as the contract allowed.

A one-page chart to fill in

Copy this into a note and complete it from your own contract.

The blanks you cannot fill from the contract are the questions to send the insurer. For the worst case of a fixed contract, the post on the minimum guaranteed value explains what the floor protects.

Key takeaways

• A guaranteed minimum is the number to plan around; a current rate or cap is the number to compare offers by, and the two can be far apart.
• Renewal rates, caps, participation rates, spreads and rider fees are commonly changeable after you buy, while a surrender schedule is usually fixed at issue.
• In the invented example a drop from 4.5% to 3% in year four cost $1,711.75 on $100,000, and a cap, participation or spread reset cut a 10% index year's credit from $8,000 to $6,000.
• Look in the contract for a minimum, a maximum, the notice period and any exit window, and ask in writing if the contract is silent.
• Fill in the one-page chart before you sign, and treat every blank as a question for the seller.