Why Annuities Sometimes Sound Too Good to Be True
The devil is in the details with multifaceted products like fixed indexed annuities, so dig beneath the rosy sales pitches to see what you’re really getting.

When you’re considering an annuity, the agent will sometimes show you an illustration. This is a table of future values and surrender charges.
If you’re considering buying a multi-year guaranteed annuity (MYGA), the illustration is usually straightforward. It will show only guaranteed values because there are no variables, except perhaps for market-value-adjustment penalties for excessive withdrawals during the surrender period. Also called a fixed-rate or a CD-type annuity, a MYGA guarantees a fixed interest rate for a term — for instance, 5.95% annually for five years (as of July 2024).
Hypothetical returns aren’t the whole story
If, however, you’re considering a fixed indexed annuity, which has many variables, the agent will usually show you an illustration with multiple pages or columns. One set of pages or columns shows the guaranteed cash values. You’ll also be shown a “hypothetical” illustration that paints a rosier picture. It shows how much your annuity would be worth in future years if it outperforms guaranteed rates. Most agents focus on the hypothetical portions of the illustration.
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A type of deferred annuity, indexed annuities credit interest to your account based on annual changes to a market index, such as the S&P 500 or Dow Jones Industrial Average. You receive an interest credit annually when the index value rises.
But when that value falls, you don’t lose anything. Your principal and all previously credited interest are always protected, even if the stock market crashes. In effect, you can have your cake — part of it, anyway — and eat it, too. And that’s why this unique vehicle is so popular.
However, there are upside limits. Interest earnings will usually be based on only a portion of the change in the market index over each index-crediting term, usually one year. In exchange for the added guarantees and principal protection, most likely you will not receive 100% of the index market gains in any year.
Including all these factors, the hypothetical illustration will show future values based on various future market returns. Since the stock market has historically done very well over the long term, the odds are that a well-chosen index annuity will have good long-term performance, too. But past performance does not guarantee future results.
That doesn’t mean that the hypothetical illustration is worthless. It isn’t. But you need to take it with a grain of salt. Consider both the guaranteed figures (the worst case) and the rosier upside possibilities.
Income account value and cash account value are not the same
If you are considering an indexed annuity with an optional income rider, the illustration will usually also show the “income account value,” which is used to calculate your future guaranteed lifetime income payment. These annuities let you either activate a lifetime income payment or take out cash withdrawals or pass down the annuity value to your spouse or other named beneficiaries.
Don’t confuse income account value with your “cash account value.” Given that they sound almost identical, it’s not surprising it’s confusing.
Some agents will claim an indexed annuity has a 7% or 8% guaranteed rate. That may be semi-accurate, but the agent might not fully explain (or in some cases even understand!) that this attractive rate is only used to arrive at your “income account value.” It is not applied to your cash account value. It is not money that can be withdrawn as a lump sum or rolled over to another annuity. That value has a much lower guaranteed rate.
That’s not to say that the guaranteed rate on the income account value is meaningless. It’s one key thing to consider when comparing annuities. But you also need to know any guarantees that apply to your cash account value, in case the stock market enters a prolonged downturn.
Big upfront bonus? Remember the no-free-lunch principle
Be wary of high introductory interest rates or large upfront bonuses. They can be tempting, but they usually come with a cost, typically lower performance in future contract years when compared with a product that doesn’t offer a bonus. The issuing insurer has to eventually recoup its initial “generosity.”
When an annuity offers a large bonus, it must be adjusted in other ways for it to remain profitable for the insurance company. A bonus annuity may not credit interest as generously as a similar non-bonus index annuity. For instance, there may be a lower annual cap or participation rate, which both limit the annuity’s growth potential.
The bigger the bonus, the longer your funds will probably be tied up in the annuity via a significantly longer surrender period. During the surrender period, you’ll be assessed a penalty if you withdraw amounts beyond those allowed by the contract. Most bonus annuities have a significantly higher surrender charge penalty.
Additionally, the bonus vesting schedule may require that you keep your money in the annuity for a certain number of years to fully benefit from the bonus. In such cases, if you take your money out during the surrender period, you may forfeit all or a portion of the previously credited bonus. Of course, you can avoid all penalties by not taking out excess funds during the surrender period.
Index annuities have more complexities than other fixed deferred annuities, so it’s particularly important to understand their features and guarantees and not be overly swayed by the most optimistic possibilities. Of course, carefully look at the illustration and other features with any annuity you’re considering, and make sure the agent answers all your questions.
Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities since 1999. Ken is a nationally recognized annuity expert quoted in national media and a widely published author. A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling (800) 239-0356.
Related Content
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Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Ore., based company at www.annuityadvantage.com or (800) 239-0356.
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