Variable Annuities Assumed Interest Rate
(Spoiler alert — it's all about the income)
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Jeff Green has held a variety of sales and management roles at life insurance companies, Wall street firms, and distribution organizations over his 40-year career. He was previously Finra 7,24,66 registered and held life insurance licenses in multiple states. He is a graduate of Stony Brook University.
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Neel Lane is an independent contract paralegal who specializes in Medicaid and VA benefits. He helps people access and maximize the benefits that they're entitled to. He has over 30 years of experience in this area.
Uncle Sam wants us to save for retirement because (let's face it) for most people Social Security is just not going to be enough. That’s why variable annuities have special features and tax benefits. They are intended to help savers build wealth and create retirement income for life. Insurance companies offer consumers many lifetime income options, including assumed rate of interest choices.
Variable annuities have many features and details. Searching through the options can be time-consuming. A professional independent insurance agent can simplify the process and guide you through it.
What Is the Assumed Rate of Interest of a Variable Annuity?
Some of the variable annuity income options that insurance companies offer are based on how the market performs. So the income in some years could be higher than in others. The assumed rate of interest is what insurance companies use to calculate the initial variable income payments from an annuity.
The initial payment is calculated based on your age, sex, the assumed rate of interest, and the accumulated value of your variable annuity.
If the investments that you selected perform better than the assumed interest rate, your payment will be higher. If the performance of investments that you selected are lower than the assumed interest rate, your payments will be lower.
Creating Retirement Income With Variable Annuities
One of the features of variable annuities is the number of options available when it comes to income. All of the annuity options are available as a variable or fixed guaranteed payment. Living benefit income riders are designed to guarantee a minimum income.
The chart below summarizes variable annuity retirement income options.
| During Lifetime | At Death | Advantages | Disadvantages | |
| Life | Pays income for annuitant’s life | None | Highest income. Partly taxable | No refund of unused principle |
| Life and 10 years certain | Pays income for life. Not less than 10 years | Balance if death occurs before the end of 10 years | Protection for beneficiaries. Partly taxable | Lower Income |
| Life and 20 years certain | Pays income for life. Not less than 20 years | Balance if death occurs before the end of 20 years | Protection for beneficiaries. Partly taxable | Lower Income |
| Life with cash refund | Pays income for life. Payments are at least the specified refund amount | Balance of refund amount | Protection for beneficiaries. Partly taxable | Lower Income |
| Period certain | Pays income for a specified number of years | Balance of payments | Useful for certain planning purposes | Outliving income |
| Joint & survivor 100% | Pays income for longer of two lives | No further payments at 2nd death | Surviving spouse continues to receive income for life. Partly taxable | Lower Income |
| Guaranteed lifetime withdrawal benefit single life | Pays income for annuitant’s life | Balance of account | Access to account values, death benefit | Income taxed as withdrawals |
| Guaranteed lifetime withdrawal joint life | Pays income for lifetimes of annuitant and 2nd life | Balance of account at 2nd death | Access to account, death benefit | Income taxed as withdrawals |
Why Use a Variable Annuity for Retirement Income?
The idea behind annuities is that they are the only financial product that can guarantee an income for life. That's important because these days people are living a lot longer than previous generations did.
In fact, running out of money in retirement is a top financial concern of Americans, according to the Personal Financial Planning Trends Survey by the American Institute of CPAs.
For some investors, creating a portion of their retirement income that benefits from market performance is a way to keep up with inflation. Inflation can have a serious impact on retirement income.
If you had retired in 2008 on $100,000 of income, in 2018 you would need $121,684 to buy the same things, based on historical inflation rates.
The disadvantage, of course, is that in years when the market is down, your income could be less than the previous year. That's why variable annuities have other income options with built-in guarantees.
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Saving Money on Taxes Means More Retirement Income for You
Variable annuities accumulate money in investments selected by the owner, called subaccounts. Like mutual funds, subaccounts are professionally managed and diversified.
Unlike mutual funds, capital gains and dividends from subaccount investments are not taxable until money is withdrawn from the variable annuity. Transfers between subaccounts are not taxable. For investors who frequently rebalance their portfolios, tax-free transfers are an important feature.
So when you save on taxes, instead of Uncle Sam getting the money, it grows in your account.
Sounds Great, What's the Catch?
When you take a distribution from a variable annuity, it is taxed as gains first. That means that the income is fully taxable until all growth is taken out. The income is then taxed at the ordinary income rate instead of the lower capital gains rate. There's a 10% penalty for taking distributions prior to age 59-1/2.
Some income options, life only, and life and certain are partially taxable.
Income from variable annuities in a pension plan or IRA is fully taxable.
How Much Do Variable Annuities Cost?
The insurance company charges fees and expenses for the features of variable annuities. Fees and expenses can range from .6 % for low-cost options to 4% and more to include rider options. The chart below is a summary.
| Charge | Typical Charge | Description |
| Mortality & expense | 1.25% of the account value | Cost of providing insurance |
| Management fees | .25% - 2% of subaccount value | Fees paid to subaccount investment managers |
| Administrative fees | $25.00 - $50.00 per transaction | Cost of transactions and record-keeping |
| Surrender charges | 7%, 6%, 5%, 4%, 3%, 2%, 1%, 0 | Charge declines over a period of years (usually five to seven). Withdrawals up to 10% of the account value are usually free of surrender charges |
| GMIB, GLWB | 1% and up of benefit base | Charges for guaranteed minimum income riders |
| GMAB | 1.4% and up of the benefit base | Charge for optional guaranteed minimum accumulation benefit |
| Enhanced death benefits | .65% and up of the benefit base | Charges for stepped-up death benefit option |
| Premium tax | Premium-based | Eight states charge a premium tax: CA, FL, ME, NV, PR, SD, WV, WY |
Why Do It Yourself?
Variable annuities can be an important part of your retirement plan. While they have many features and benefits, they are not for everyone. Be sure to talk to your independent insurance agent. They can help you decide if a variable annuity is right for you.
Advisors Guide To Annuities John Olsen