Key Takeaways
- A market value adjustment (MVA) is a contract clause associated with deferred annuities.
- Insurance companies use market value adjustments to reduce their risk of loss should the annuitant take too many early withdrawals or cancel the contract during the accumulation phase.
- A market value adjustment can also positively impact the contract value of your annuity in falling interest rate environments.
What Is a Market Value Adjustment?
A market value adjustment (MVA) is a contractual stipulation associated with deferred annuities. The period between the purchase of a deferred annuity and the beginning of its income stream is known as the accumulation period. During this period, the money in the annuity grows on a tax-deferred basis.
While the annuity owner may be able to decide when to begin the income stream, to avoid a penalty, they must typically wait a specified amount of time. This period is known as the surrender period.
An MVA is a monetary adjustment that some annuity providers apply to a contract if the owner makes withdrawals beyond what’s allowed during the surrender period. The MVA can have a positive or negative effect on the withdrawal depending on the conditions of the market when the withdrawal or surrender occurs.
While the exact terms and calculations of an MVA vary widely from company to company, the effect of an MVA generally reflects an inverse relationship with interest rates. That is, if interest rates have gone up from the time someone purchases an annuity to when they surrender or withdraw, then the MVA will lower the value of their payout. If interest rates have gone down over the years the person has owned the annuity, the MVA will increase the value of their payout.
An MVA can never reduce the cash surrender value of an annuity below the minimum guaranteed in the contract. MVAs also don’t apply to amounts withdrawn after the surrender period within the penalty-free amount allowed during the surrender period. Most contracts allow the owner to withdraw up to 10% of their annuity’s value each year without penalty.
Is An Annuity Right For You?
Right now, because of the high interest rates, clients have replaced their current annuity contracts with higher-paying ones. This can be tricky because if they bought when bond prices were high and interest rates low, they take a major hit from MVA charges when selling the annuity because the insurance company must liquidate the bond position at a loss due to the sharp rise in interest rates. Replacing a policy can be beneficial as long as the financial benefit justifies any loss incurred.
John Stevenson, CFFOwner and Advisor at Stevenson Retirement SolutionsJohn Stevenson, a Certified Financial Fiduciary®️, specializes in securing retirements with tax-free accounts. With a focus on guaranteed retirement, he’s ensured none of his clients suffer from market fluctuations. As a renowned educator and podcast host, John empowers thousands weekly, sharing his expertise in minimizing taxes and protecting against financial downturns.
How Does an MVA Work?
Market value adjustments operate by comparing the relevant interest rate’s value on the contract’s issue date with the rate at the time the owner withdraws from or surrenders the annuity. The adjustment applies inversely to the amount withdrawn or surrendered.
Understanding how an MVA might affect your annuity can be complicated, so let’s look at an example of how an annuity provider might apply an MVA to a fixed annuity contract.
MVA Example: $250,000 Fixed Annuity
- If you own a $250,000 fixed annuity with a 10-year surrender period.
- Your contract allows for penalty-free withdrawals of 10% annually during the surrender period.
- Withdrawals in excess of the penalty-free allowance are subject to a gradually declining penalty that starts at 10% and reduces by 1% each year. You are near the end of the third year of the surrender period, which means you’ll pay an 8% penalty on withdrawals that exceed the penalty-free allowance.
- Since you purchased your annuity, the relevant interest rate (in this case, the yield on a 1-year U.S. Treasury bond) has risen by 2%.
- You withdraw $50,000 from your annuity contract.
From here, we have to break down how much of that money is subject to penalties and apply the surrender penalty and the MVA.
Initially, only $25,000 of the withdrawal incurs a penalty, as your contract permits a penalty-free withdrawal of 10% from your annuity’s $250,000 value. The remaining $25,000 is subject to both the 8% surrender charge and the MVA.
Different annuity companies calculate MVAs differently, but the following formula is a reasonable example.
[(1+ Interest Rate at Purchase) (1 + Interest Rate at Withdrawal)] Years – 1 = MVA
(1.01 1.03) 3-1 = 0.0571 or -5.71%
Once you know the MVA percentage, you can calculate the net withdrawal amount. Multiply the $25,000 excess withdrawal amount by the surrender penalty to find out how much the insurer subtracts for the surrender charge. Then multiply the excess withdrawal by the MVA percentage to determine how much will be added or subtracted from the total withdrawal due to the MVA.
Gross Withdrawal – (Excess Withdrawal Surrender Penalty) + (Excess Withdrawal MVA)= Net Withdrawal
$50,000 – ($25,000 0.08) + ($25,000 -0.0571) = $46,572.50
As you can see, the early withdrawal resulted in the loss of $3,427.50 ($50,000 – $46,572.50 = $3,427.50), which includes an MVA of $1,427.50 ($25,000 × .0571 = $1,427.50).
Why Do MVAs Exist?
Annuity companies use MVAs to protect against investment losses that can happen when an annuity’s owner withdraws funds or cancels a contract in the early stages of the accumulation period.
When you purchase a fixed deferred annuity, the issuer takes your money and invests it in fixed-rate assets, such as bonds. The issuer does this with the goal of growing your money to a level that will cover issuance expenses, provide you the promised stream of cash payouts and generate a worthwhile profit.
However, given their fixed-rate nature, the values of these investments are highly sensitive to changes in interest rates. They tend to do poorly when rates are rising and better than expected when rates are falling.
Because of this interest rate sensitivity, annuity issuers need the contract’s full accumulation period to produce the adequate funds. If the annuity’s owner pulls their money out sooner than the issuer anticipates, the issuer could lose money when they try to sell the investments, especially if interest rates have risen.
The MVA is the tool the issuer uses to protect against these potential losses. Fundamentally, this shifts risk to you, the owner of the annuity. From the annuity owner’s perspective, this might seem like a downside, but it’s important to remember that MVAs can be positive or negative. In addition, by employing an MVA clause to offset their risk, the insurance company can offer more competitive crediting rates than what would otherwise be feasible.
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Market Value Adjustment Frequently Asked Questions
When an annuity owner withdraws money early, the annuity issuer can apply a market value adjustment by comparing a relevant interest rate at the beginning of the contract to the rate when the withdrawal happens and either adding or subtracting from the value of the withdrawal. If interest rates have gone up since the contract was issued, the value of the withdrawal decreases, and if rates have fallen, the withdrawal increases in value.
Every insurer has its own formula for calculating a market value adjustment. An insurer may calculate the change in interest rates since you first bought the annuity and adjust the amount of its loss or gain based on current rates or the interest rate when you made your withdrawal.
A market value adjustment can be positive or negative for the annuity owner. If interest rates have gone up since you bought the annuity, the insurance company will suffer a loss, which they may pass on as an MVA. On the other hand, if interest rates have gone down, it can benefit the owner by increasing the surrender value of the annuity.
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