Understanding Benefit Base vs. Cash Value in an Annuity

The Benefit Base: Your Special Store Coupon

Imagine you receive a coupon from your favorite store. This coupon is not cash; it has no value outside the store. It’s only useful for getting a discount on a future purchase or redeeming a special offer. In the context of an annuity, the benefit base operates similarly to this coupon.

The benefit base is a calculated value within an annuity contract that is used to determine certain benefits, such as guaranteed income payments or death benefits. It often includes bonuses or roll-ups that make it appear more valuable than the actual cash value of the annuity. However, just like a store coupon, the benefit base cannot be cashed out or transferred. It’s a notional figure that exists solely to determine the benefits you’re entitled to under specific conditions. 

The Cash Value: Real Money in Your Pocket

On the other hand, the cash value of an annuity is akin to the actual money you have available to spend. It’s the amount of money you would receive if you decided to surrender the annuity before the income phase or the sum that could be transferred if you choose to annuitize the contract.

While the cash value is a real, tangible amount you can access, it might be less than the benefit base. This difference is crucial, especially if you’re considering surrendering your annuity or need to assess its liquidity.

How These Concepts Play Out

Consider a scenario where you have an annuity with a benefit base of $100,000 and a cash value of $85,000. The $100,000 benefit base might be used to calculate your future guaranteed income, providing you with a larger stream of income than if it were based on the $85,000 cash value. However, if you wanted to cash out today, you’d only receive the $85,000.

This disparity can be a source of confusion and disappointment for annuity holders who mistakenly believe that the benefit base is equivalent to their cash value. Understanding this distinction is crucial for making informed decisions about your financial future.

Considerations When Reviewing Benefit Base in Annuities

Roll Ups

Benefit Bases commonly feature a roll up rate which is a guaranteed rate at which the benefit base increases each year. For example, an 8% Rollup means the benefit base will increase by 8% from one year to the next.

Roll Up Caps and Type

Some roll up’s limit how long the roll up is given to the contract holder. For example, an annuity might provide roll ups for the first 10 years then none after that. Additionally, some contract may specify a compound roll up versus a simple roll up. See Basic Statistics and Other Finance Terms – Gilbert Wealth

Step Ups

Some contracts provide for a step up of the benefit base increases the benefit base to the greater of the benefit base or the cash value. This can come into effect if the investments inside the annuity increase faster than the benefit base crediting. 

Fee Calculations

Some annuity contracts base the fee of the rider which creates the benefit base on the benefit base and not the contract value. While this seems trivial, it can heavily influence the contract value when income begins. The reason is that the benefit base generally does not go down even if you take income, but the cash value does.

For example, if the benefit base is $500,000 with a 1.5% fee but the cash value is $200,000 either due to withdrawals, investment performance, or lack of growth, the 1.5% fee turns into a 3.75% fee on the cash value ($500,000 x 1.5% = $7,500 / $200,000 = 3.75%).

Conclusion

The next time you review your annuity statement, remember the coupon analogy. The benefit base, like a store coupon, has its uses but isn’t directly cashable. The cash value, however, is the actual amount you can access or move. Understanding the difference between these two can help you better navigate your retirement planning and ensure that your expectations align with reality.