Key Takeaways
- Variable annuities do not have a guaranteed rate of return – instead, the insurer sets an assumed interest rate (AIR), which represents how much they expect the annuity to grow.
- The AIR can be used to predict the value of variable annuity payments. The higher the AIR, the larger you can expect your payments to be.
- Variable annuities typically have an AIR between 3% and 7%.
What Is the Assumed Interest Rate?
The assumed interest rate is the interest rate that insurance companies assign to variable annuities. These financial products allocate your initial lump-sum premium to subaccounts in an investment portfolio. Subaccounts may hold stocks, bonds or other securities.
Variable annuities offer the potential for higher gains as compared to fixed annuities — but they also carry risk.
Because returns from variable annuities can fluctuate, insurance companies use the assumed interest rate to calculate your initial payment. It’s a sort of benchmark of what to expect from subsequent payments.
You don’t pay taxes on earnings until you take money out of an annuity.
It’s important to keep in mind that the AIR is not a guaranteed rate of return on the investments in your underlying subaccounts.
“The easiest way to think of the AIR is as an earnings target,” Elle Switzer, director of Annuity Product Management at TruStage, told Annuity.org.
“If the return on the variable funds is equal to the AIR, the income payment will stay the same. If the variable funds return more than the AIR, the income payment will increase. And, if the variable funds return less than the AIR, the income payment will decrease,” Switzer said.
The assumed interest rate is not a guaranteed rate you’ll earn going forward, but a target or benchmark rate for a variable annuity.
Brandon Renfro, Ph.D., CFP®, RICP®, EACo-Owner of Belonging Wealth ManagementAs a Certified Financial Planner™ professional and Retired Income Certified Professional®, Brandon Renfro is well-versed in the financial information and strategies needed to meet retirement goals. In addition to co-owning Belonging Wealth Management and assisting clients, Brandon writes regularly for financial publications.
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Estimating Your Variable Annuity’s Payout
The AIR, which usually ranges from 3% to 7%, plays an important role in determining the expected payments from a variable annuity. You can estimate the payout of your variable annuity contract using the AIR along with other factors like your age and how much you’ve invested in the annuity.
However, this is only an estimation, as variable annuity payouts change based on the performance of the contract’s subaccounts. You may receive more money during months when the annuity’s underlying assets perform well. If investment performance falls below the AIR, payments decrease during the payout phase.
The exposure of market volatility is what gives variable annuities their higher earning potential, but it can also make these products risky for retirement savers. This is why over 80% of variable annuity customers purchase living benefits.
Living benefits are riders that can be added to an annuity contract and provide certain guarantees while the annuitant is alive. These include the guaranteed minimum income benefit, or GMIB, and the guaranteed minimum withdrawal benefit, or GMWB.
Variable annuity investors use living benefits to ensure they’ll receive a certain amount of income from their annuity, mitigating the risk of a market downturn lowering their payments.
Example of Assumed Interest Rate
Let’s assume your variable annuity is beginning to pay out. When you bought your annuity, you paid a $100,000 premium to fund the policy and agreed to a 4% assumed interest rate.
If the AIR is 4% and the growth of the investments within your variable annuity’s portfolio net a 4% return, you’ll receive the monthly payout you expected.
In general, the higher the AIR, the larger you can expect your payments to be.
But remember, the AIR is just one of several factors used to determine your minimum monthly payment. Your age, the type of annuity and any living benefits or death benefits also play a role in calculating your minimum payments.
Because the AIR heavily influences the size of your retirement income, it pays to shop around for an insurance company willing to offer you a higher AIR. You may want to consult a financial advisor who can help you find a variable annuity that best fits your needs.
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Frequently Asked Questions About Assumed Interest Rates
Most variable annuities do not have a guaranteed interest rate – instead, they have an assumed interest rate, which represents how the insurer expects the annuity’s subaccounts to perform.
The rate of return on a variable annuity is tied to the performance of its underlying investments – the assumed rate of return on most variable annuities is between 3% and 7%.
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