SAVING THE MONEY YOU SAVE – THE BONUS ANNUITY (PART 2)

In last week's article, I introduced you to the bonus annuity (along with a few important disclaimers). This week, I would like to illustrate in a little more detail how the bonus annuity works, and how it might be a great tool to start your savings.

Let's continue with the example from last week. Let's say you want to save $100 a month for the next five years. That's $6,000 of savings ($100 x 60 months). If you put that money into traditional savings account at 3% (a very generous rate in today's market), your account would be worth about $6,481 after 60 months.

Now, let's take the same amount of money and contribute it to a bonus annuity. Let's assume that the bonus annuity is paying 3% interest on the account (an average rate among today's annuities), and is also paying a 7.5% bonus on each monthly contribution you make. In effect, for each $100 you put in, the company credits $107.50 to your account ($100 + $7.50 bonus). Using these assumptions, at the end of 60 months, your account balance would be around $6,967. That's almost $500 more than the savings account. Think of it as though the insurance company made an extra month's deposit for you for each year.

There's another advantage to a bonus annuity that makes your money work even harder. The interest earnings inside an annuity are tax-deferred, which means you don't pay income tax on the earnings until you withdraw the money. Let's assume you're in the 15% tax bracket. If you had used the savings account, you would have paid $72.12 in income taxes over the 5-year period. But by using the bonus annuity, that money stays in the account and earns interest tax-deferred. Although you'll eventually pay taxes on the earnings when you draw them out, you get to use Uncle Sam's money to make more money for yourself until then.

By now, you're probably asking yourself, “why would the insurance carrier give me bonus money?” That's a very important question; obviously there's something in it for them. The companies want to give you an incentive to do business with them and put money in your account. They invest your money and use the earnings to 1) pay your interest, 2) pay their expenses, and 3) make a profit. The more money you save, the more profit they make.

The longer the company can keep your account and invest for the long-term, the more money they make for you and for them. Therefore, most of these bonus annuity contracts have a period of time called a “surrender period” where you are penalized if you draw the money out early. That way, you are more likely to keep your account with them to avoid penalties. The surrender periods vary in length from just a few years to as long as 14-15 years. Usually, the penalty percentage is larger in the early years, and reduces each year until it reaches zero.

Surrender penalties sound a little scary, but there are several things working to your advantage that significantly reduces their impact. Next week, I'll tell you why it's not really a bad thing to make a long-term commitment to a bonus annuity, and how you can avoid the surrender penalties in most instances. As always, if you have any questions or have comments, please drop me an e-mail at david@davidwbarnett.com.

If you didn't catch Part 1 of 2, go HERE.

Also, if you attended my coupon class, I forgot to give you guys something. I have a coupon for a free ($95 value) Financial Session with my dad, David W Barnett. If you would like this coupon, shoot me an email. Go HERE for more information on the coupon.