Market Value Adjustment on a Fixed Annuity

Although fixed annuities are designed as long-term investment products, you can access your cash before your contract matures. Taxes and penalties may erode your earnings while a market value adjustment clause could also impact your returns. If your contract contains such a clause, you cannot get back less than you invested but your earnings are highly sensitive to interest rate movements.

Fixed Annuity

A fixed annuity contract typically lasts for between four and 10 years. Your investment grows on a tax-deferred basis. Withdrawals are subject to both state and federal income tax. As the product title implies, these contracts typically pay a fixed rate of interest. In some instances, the rate remains fixed over the whole contract term while in other instances it resets on an annual basis. Generally, annuity contracts include minimum rate guarantees that prevent annual rate adjustments from falling below a set base rate.

Withdrawals

Insurance companies invest your purchase premiums in low risk securities such as government bonds or commercial paper. When you make a withdrawal, your insurer sells the underlying investments to free up your cash. To discourage frequent withdrawals, annuity issuers typically impose surrender charges on premature withdrawals. Surrender fees apply to withdrawals of earnings. Some firms even assess penalties on withdrawals of principal. Penalties can amount to 10 percent or more of your withdrawal. You pay these fees in addition to any applicable taxes. Depending on the rate environment, a market value adjustment clause may offset your surrender fees or add to your losses.

Understanding the Adjustment

Insurance firms have to buy and sell securities every time an investor buys an annuity or makes a withdrawal. If interest rates are rising, older, low-interest rate bonds become less valuable because newer higher-yield bonds are readily available. If you make a withdrawal, your annuity provider may take a loss by selling older bonds at a discount. Conversely, if rates are falling, your insurer can make a profit by selling high-interest bonds at a premium. If your contract includes a market value adjustment clause, your insurer retroactively adjusts the rate of interest on your contract based upon the prevailing rate environment. Your rate rises if interest rates as a whole have fallen but you lose money if rates have risen.

Considerations

In a falling rate environment, you can potentially profit by cashing in your fixed annuity contract before the term ends. Even with surrender fees, a substantial adjustment could enable you to make a healthy profit on your original investment. On the downside, you then have to find a new place to park your money. If rates are declining, you may not find an investment offering the kinds of returns you could have had if you held your annuity until maturity. Some investors try to time the market by cashing in fixed annuities before interest rates drop. However, like any investment strategy, market timing can be a risky business.