Average Annuity Payout Rates & Average Annuity Returns

An annuity offers you something that no other financial product can: guaranteed retirement income.

That’s pretty great in itself, but annuities have another benefit that makes them attractive to savvy investors: the opportunity to grow money tax-deferred.

These earnings are called annuity returns, and, as we’ll discuss below, they can vary widely among annuity products, contracts, and even providers. How do annuity returns work, and what can you expect to earn? Let’s break it down and find out.

What is an Annuity Return?

Simply put, an annuity return is the money your annuity accumulates over the life of your contract. This is different from the principal, which is the money you put into the annuity by paying premiums. This is also different than the crediting rate, which tells you how much annual interest you’re earning in your annuity.

How Are Annuity Returns Different From Payout Rates?

Before we move on, we want to clear up any confusion around annuity returns and payout rates. When you’re looking at income annuities (a type of annuity that gives you guaranteed income for a number of years), you’ll often see payout rates (sometimes called “annuity rates”).

These payout rates can be high, sometimes as high as 8%. That can seem like a great deal—a steal even. But here’s the catch: Payout rates are not the same as rates of return.

A payout rate tells you how much of your premium you’ll get in payouts each year. But it doesn’t tell you how much you’ll earn. Payout rates assume you’ll annuitize your contract, meaning you’ll choose to get periodic payouts for a number of years instead of a lump sum payout.

In this sense, the payout rate helps you predict how much you’ll receive in annuity payouts each year, relative to how much you’ve paid in premiums.

For example, let’s say you put $100,000 in an income annuity with lifetime payments at an 8% payout rate. With lifetime payments, you’ll receive payouts from your annuity until you die. And with an 8% payout rate, your annuity will pay you $8,000 (8% of $100,000) every year for the rest of your life.

But it doesn’t mean your annuity will earn $8,000. Again, payout rates are associated with income annuities, such as the single-premium immediate annuity (discussed below). So, if you see a high payout rate on an income annuity, do not compare it with the crediting rate on deferred annuities, such as a MYGA annuity. They are very different.

What Factors Influence Annuity Returns?

Many people think annuity returns are only as strong as their annual interest rates. While they do depend on interest rates, annuity returns can be complex (especially on variable and fixed index annuities). In sum, here are the most important factors that influence annuity returns.

1. Interest Rates

The interest rate, or crediting rate, is the engine of your annuity return: it tells you the rate by which your premiums will grow each year. Crediting rates depend heavily on the type of annuity you buy. For fixed annuities, your annuity rate is set by the insurance company at the beginning of your contract.

These rates are locked into place, meaning your money will grow at the same rate for a specific period of time regardless of market volatility. Variable annuities, on the other hand, have variable rates. Your rate is tied to an underlying investment.

When these investments go up or down, your rate follows.

2. Principal

The principal is the money you use to fund your annuity. You fund it by paying premiums to your annuity provider. In general, the higher your principal, the more money you’ll earn in interest.

For example, if you put $100,000 in a five-year deferred annuity with a 3.25% crediting rate, you'd earn $17,341 after five years. Not bad! But if you doubled your principal to $200,000, you'd double your return, too. In a five-year deferred annuity, you'd get a whopping $34,682 in earnings.

3. Life Expectancy

For income annuities, life expectancy plays a major role in your returns. In general, the longer you live, the more payouts you receive. And the more payouts you receive, the higher your overall return will be. Think of it this way: Annuities are the opposite of life insurance.

With life insurance, you protect against dying too early. The life insurance company pays your beneficiaries, regardless of how much you paid in premiums. With income annuities, you make the opposite bet. You bet you're going to live longer than the insurance company expects. If you do, you'll keep getting payouts, the sum of which will eventually exceed the premiums you've paid.

In essence, you are protecting yourself from outliving your income!

4. Annuity Fees and Agent Commissions

Fees and commissions reflect the true price of your annuity. In general, the more complex your annuity contract, the more you'll pay in annual fees and commissions.

Keep in mind: Just because you don't see "fees and commissions" listed in your annuity contract doesn't mean they're not there. Many fees (especially commissions paid to agents) are built into your rate of return. So, even if you're not paying these fees directly, your crediting rate may be lower because the insurance company has to pay them.

5. Early Withdrawals

Remember, the higher your account value, the more money you’ll earn in the long run. If you withdraw money early, you’ll lower your account value—and your rate of return. On top of that, if you withdraw during your surrender charge period, you could pay a surrender charge. A surrender charge is an early withdrawal fee, and it's shown as a percent in your annuity contract.

Surrender charges are calculated by multiplying the surrender charge percent by the amount you’re withdrawing from your contract. The surrender charge is then deducted from the total withdrawal amount.

For example, if you withdraw $2,000 during the first year of your contract and the surrender charge for that year is 8%, you’d pay $160 in surrender charges and receive $1,840. Your contract might allow you to withdraw some or all of your premiums without a penalty.

Penalty-free withdrawals are usually around 5% – 10% of your account value, though, for certain medical conditions and emergencies, you can sometimes withdraw more penalty-free. But again, the point is the same: The more you withdraw, the less interest you earn.

6. Extra Riders

Some annuities come with riders, which are benefits added to your annuity contract to help you mitigate risks. For instance, you could buy a “cost of living rider,” which adjusts your income payments to inflation. Riders add extra security, sure, but they come with additional charges that will lower your returns.

7. Financial Strength of Annuity Provider

Your annuity return is only as strong as the insurance company issuing your contract. You may land a high annual interest rate with principal protection, but if your insurance company can’t back its promises with cash, you’ll eventually find yourself in a tough spot. Before you buy an annuity with an insurance company, check their financial stability. Use a third-party rating agency, such as AM Best, to see what rating they've received. The higher their rating, the less likely the insurance company is to become insolvent.

How Do Annuity Returns Differ By Type?

Annuities vary by their crediting rate strategy (MYGA, Fixed Indexed Annuity, and Variable) and also by when they payout (Immediate or Deferred). These types of annuities are each designed to accumulate and distribute returns differently.

Some annuities have straightforward accumulation and distribution phases (such as the MYGA). Others involve more risk and can get complicated. In sum, here’s how returns work on common annuity products.

1. Multi-Year Guaranteed Annuity (MYGA)

Multi-year guaranteed annuities (MYGAs) are the simplest annuity product on the market.

With a MYGA, you hand a lump sum to an insurance company, and, in exchange, you get a fixed crediting rate for the term you choose. Your money grows by that rate for the entire length of your contract (3, 5, 7, or even 10 years). When your contract is up, you can renew into a new term (usually at a new crediting rate), or you can choose a payout option. Your return depends on your crediting rate. And the best part—MYGAs have income tax-deferred compound growth, too, which helps your money grow exponentially over time.

2. Single-Premium Immediate Annuity (SPIA)

A single-premium immediate annuity (SPIA) is, well, immediate. You pay a lump sum upfront and, within the year, you’ll receive an income stream, either for a specific period of time (called period certain) or for the rest of your life (lifetime payments).

How do you calculate your return in a SPIA? Truthfully—it’s tricky. Insurance companies don’t usually advertise crediting rates on SPIAs like they would on a MYGA.

You’re often given a payout rate, which tells you how much money you’ll get back each year. For example, if you bought a $100,000 SPIA with a 5% payout rate, you’d receive $5,000 a year. The return in a SPIA depends on how long you live and how many payouts you receive.

So again let’s say you bought a $100,000 SPIA with lifetime income and no death benefit. And let’s go further to say your insurance company gives you a payout rate of 5%—or $5,000 a year.

In the first year, you only get $5,000, which means technically, you start your SPIA in the negatives: If you died within the first year, you would lose $95,000. But let's say you didn't die in the first year.

Let's say you live for another 40 years. Not only do you get your original $100,000 back (which comes to you after 20 years), but you also earn $100,000.

This “$100,000” is your return. Here’s the thing: For SPIAs with lifetime payments, you won’t know your final return until you die (convenient, right?), which is why insurance companies usually advertise payout rates instead of return rates. If you buy a SPIA with period certain payouts, on the other hand, your insurance company should give you a rate of return upfront, since the number of payouts is defined.

3. Deferred Income Annuity (DIA)

Deferred income annuities are the opposite of SPIAs: Your payouts don’t start immediately but at a later date (the deferred part). Like a SPIA, you have to live long enough to get your payouts back to see positive returns. But, in addition, you have to live long enough for your annuity payouts to start, too.

Because an insurance company doesn’t pay you immediately, you may see higher payout rates on DIAs. Typically, the longer your accumulation phase (that is, the period of time during which your money sits and grows), the higher your payout rate at the end.

4. Fixed Indexed Annuity (FIA)

The rate of return on a fixed indexed annuity (FIA) is a bit complicated. In its simplest form, FIAs are tied to an underlying market index, such as the S&P 500. If that underlying index performs well, you’ll enjoy higher returns. If it performs poorly, you’ll receive lower returns or, worse, no returns. Sounds simple, right? Well, let’s peel back the first layer of complication. FIAs come with a guaranteed minimum return, usually 0% to 3%. That means, if your index market performs in the negatives for your entire contract, you’ll get the guaranteed minimum. You might not earn much money. But at least you’re not throwing away what you put in.

Now, the next layer of complication. If your index market soars, don’t expect the full gain. Your earnings are capped at a certain rate. Your insurance company will give you a maximum rate of return, and, it follows one of the following three patterns.

1. Interest Rate Caps

Your contract may give you a flat maximum rate of return. For example, if you had an 8% interest rate cap and your index gained 12%, your return would only be 8%.

2. Participation Rates

A participation rate is simply a percentage of the gain. Let’s say your percentage rate is 50%. Let’s further say your index grows by 12%. Your return would be 50% of 12%, which is 6%.

3. Spread/Margin/Asset Fees

Instead of a participation rate, you may get a spread, margin, or asset fee.

This is a flat fee that’s deducted from your gain. For instance, let’s again say the index tied to your FIA grows by 12%. Let’s also say your spread/margin/asset fee is 4%. Your insurer will subtract 4% by 12%, and award you with an 8% gain. As you can see, the return on a FIA is far from simple.

Before you buy a FIA, make sure you read the fine print on your contract carefully, preferably with a financial advisor.

5. Variable Annuity (VA)

Finally, the variable annuity. The returns on variable annuities are the least predictable but have the biggest potential return.

Your premiums are reinvested into subaccounts (individual stocks or mutual funds), and the performance of these subaccounts determines how much you earn. Note: You can lose money in a variable annuity. In addition to unpredictable interest rates, variable annuities are riddled with fees, including investment fees, mortality and expense credits, and account fees.

Before you buy a variable annuity, make sure you know how the fees will impact your return.

Some Investments Offer Higher Returns. Why Choose an Annuity?

Look, here’s the thing: Annuities aren’t investments. They’re insurance products that offer you guaranteed income, either in the form of periodic payments or a lump sum you withdraw in retirement. If you look at annuities as some kind of investment portfolio, you’re missing the point. Annuities are designed to give you income in retirement; the return is a bonus.

What do annuities offer retirees and those approaching retirement that investments can't? Here are three big advantages to using one in your retirement planning.

1. Guaranteed Income

It’s worth stressing: An annuity allows you to convert a lump sum (or a series of premiums) into guaranteed income payments. No other financial product can promise this. On top of that, if you buy a fixed annuity, one in which the annual interest stays the same, your rate of return isn’t affected by market volatility.

Imagine getting monthly income payments in retirement that no stock market crash or recession can take away—that’s the true value of an annuity.

2. Tax-Deferral

Like 401(k)s and IRAs, the money you put into an annuity grows tax-deferred. Unlike a certificate of deposit (CD) or savings account, you don’t have to pay taxes to the IRS on annuity returns until you withdraw the money. This gives your principal more earning power: Money that’s not spent on taxes becomes money that compounds with interest.

3. No Contribution Limits

Earnings in 401(k)s and IRAs are tax-deferred, too, which makes them great for saving for retirement. But they come with one big disadvantage: They have contribution limits. On the other hand, annuities don’t have contribution limits, allowing you to put more retirement money in a tax-advantaged account.

Want a Guaranteed Annuity Return?

Who doesn’t? At Canvas Annuity, we offer multi-year guaranteed annuities (MYGA) that you fund with qualified (pre-tax dollars) or non-qualified (after-tax dollars) money.

Our MYGAs come with guaranteed rates, which grow your money predictably over the term you choose. And, because we sell our annuities directly online, we don’t pay agents to sell them, meaning we can offer higher rates for annuities. We also understand that life happens, and sometimes you need money you didn’t think you would need.

So our MYGAs come with generous withdrawal provisions, allowing you to withdraw up to 10% of your account value penalty-free each year. And for qualifying medical conditions, you can cash out your entire annuity account. See which Canvas annuity is right for you, and we can help your money grow the safe way.