How Interest Crediting and Annuity Interest Rates Work

Fixed annuity products have some of the highest interest rates around. Especially when compared to traditional bank products, like CDs and savings accounts.

But how do insurance companies set these interest crediting rates and could these rates change?

Let’s review the facts and get some insight from an industry insider.

What Are Interest Rates?

When people want to grow their money, they deposit it in various accounts like savings accounts, CDs, annuities, bonds, and stocks.

This deposit is known as the principal. These accounts pay rates of return or crediting rates, that generate earnings on the principal.

Your money earns interest because the financial institution is investing your money in various vehicles.

A simple way to think about it is that they make money on the difference between what their investments pay them and their own overhead costs plus the rate that they pay you.

The level of risk in the underlying investment tends to determine the return rate. The riskier the investment, the higher the rate.

For example, let's say you deposit a principal with an institution (e.g., a bank or insurance company). In return, the institution pays you a rate of return.

Depending on the account, the rate can be a fixed rate or a variable rate. However, let’s stick with CDs and fixed annuities, which both have fixed rates.

The interest accumulates steadily on top of the initial principal, and your money grows over the course of the term.

There are two ways to calculate interest: simple and compound.

Simple interest means that the interest rate is applied to your principal every year.

Compound interest, however, applies the interest rate to your principal and your earnings. With compounding interest, you’re applying interest to your entire account balance. You’re actually earning “interest on the interest.” This is a great way to grow money quickly.

See the following example of simple interest vs compound interest for an initial deposit of $1,000 at a fixed rate of 5%.

Though this is only a $25 difference, imagine how significant the disparity would be if the principal were larger, and consider how the gap will continue to grow exponentially over multiple years.

Compound interest means that your principal (and the interest it generates) grows larger over time.

How Banks and Insurance Companies Set Interest Rates

Insurance company-issued fixed annuities tend to have higher interest rates than the rates banks offer for CD.

The amount of interest they can offer varies because these two entities invest your money in different ways.

How Banks Set Interest Rates for CDs

A traditional bank CD is considered a deposit of money bound by a certain amount of time that the money must remain in the account.

The bank pays you interest and uses your money for a fixed period of time.

Because your money must sit in the CD bank account for the prescribed period of time, the bank can pay you a higher interest rate than it would for a traditional savings account.

The bank uses your money to fund its investments (for instance, extending loans to bank customers). And they keep the interest they don't have to pay you for your CD.

For example, if they guarantee you a 1% return on your CD, and the investment earns 3%, they pay you 1% and keep a 2% return.

How Insurance Companies Set Interest Rates for Fixed Annuities

For traditional fixed annuities, an insurance company receives your annuity deposit. The company acts as a lender and invests your money in investments like corporate bonds, mortgage-backed securities, and other securities that generally match the time period of the fixed annuity contract (typically 3, 5, or 7 years).

The insurance company uses the largest portion of the earnings generated by these investments to pay you your promised interest rate.

The remainder covers expenses that the insurance company incurs to create and maintain the product, like marketing fees, agent fees, and other costs. It also provides a reasonable profit to the company for the risks involved in investing your money.

And it produces a reasonable return to keep the company financially solvent.

Note The more fees an insurance company must cover, the lower your crediting rate. To get the best annuity rate for you, try buying an annuity from a company with lower expenses. Canvas Annuity products have such high rates of return because of the lower cost of doing business.

Can Interest Rates Change?

The beauty of a “guaranteed” fixed-rate period, whether it is a CD or a fixed annuity, is that the interest rate promised to you cannot change during the time period selected.

When that period is over, however, the bank or insurance company can change your rate. The good news is that insurance companies have a minimum guaranteed rate stated in your annuity contract.

So even after the guarantee period expires, your rate cannot fall below the minimum rate in the contract. If your rate of interest does change, you have a period of time (usually 30 days) to move your money to another financial instrument without penalty.

Note: Interest rates are at a historical high as of October 2023. Find out if a peak in interest rates means now is the best time to consider buying an annuity or CD.

Does Buying Direct Impact Interest Crediting Rates?

Yes, buying your annuity directly from a provider positively impacts your crediting rate!

Direct fixed annuity provider Canvas Annuity and its parent company Puritan Life Insurance Company of America (Puritan Life) provide very competitive interest rates for annuity buyers who “go direct” (i.e. purchase annuities online from the company).

Puritan Life President Robert DeFeo explains, “Insurance companies are subject to a number of regulations when it comes to their permitted investments. Puritan is committed to maintaining a diversified investment portfolio that produces income and grows surplus while limiting downside risk. Our competitive focus is on changing the annuity purchasing process through online sales of our Canvas annuity products. This digital sales model allows Puritan to eliminate excess expenses inherent in the traditional sales model while reaching a large group of potentially underserved individuals through online channels.”

If you are looking for a conservative investment to meet your personal finance goals, consider a fixed annuity with Canvas Annuity.

Canvas offers superior interest rates for 3, 5, or 7 years. When you’re done letting your money grow, you can annuitize the annuity and turn on the cash flow.

Get in touch with our non-commissioned agents and find the annuity product that's right for you.