What Is a Two Tier Annuity?

Always read your disclosures carefully.

Always read your disclosures carefully.

A two-tier annuity is an investment product that requires you to invest an up-front sum in exchange for a promise of future payments. The two tiers comes from the redemption options the annuity offers. If you pull your money out over time, you earn a higher return that if you take your money out in a single lump sum. Over time, the penalty for choosing the latter grows.

Introduction to Annuities

Investors use annuities to turn a lump sum of money into a stream of payments. For instance, you may choose to put money into an annuity today that will start paying you when you retire, giving you a predictable income stream when you leave the workforce. While fixed annuities have a predetermined rate of return, variable annuities give you the potential for higher returns in exchange for additional risk. A two-tier annuity can be fixed or variable.

Two Tiers

When you purchase a two-tier annuity, the insurer usually offers two choices of return. The first is a higher rate if you annuitize your payments. This means that, if you take your payments over a long period of time, you'll receive a better rate of return. In some instances, the insurer will also give you a bonus and, for instance, turn your $50,000 annuity into a $60,000 one. However, if you choose to pull your money out of your annuity in a lump sun, you'll get a much lower rate of return.

Two-Tier Penalties

Two-tier annuities have two different types of penalties. First, like any annuity, they have a surrender charge that comes into play if you take your money out too quickly. The more significant charge is the different rate that a two-tier annuity offers. If you have to pull money out of a two-tier annuity in any way other than the one documented in your annuity agreement, you could not only not get the higher return, but could actually get less out than you put in, giving you a negative rate of return.

Recognizing Two-Tiered Annuities

Two-tier annuities aren't always labeled accurately. Sometimes, they can be called a single-tier annuity or a modified single-tier annuity. To spot a two-tier annuity, look at the rate of return. If it's higher than what you'd get on a comparable regular annuity, you might have a two-tier product. In addition, ask the person selling you the policy if there are multiple interest rates that come into play. Even more importantly, read the disclosures. A two-tier annuity might be the right investment for you, but given the risk that you take if you have to withdraw your money early, it's best to enter into one with open eyes.

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