If MVA annuities pay a higher rate, why buy anything else? Because, if interest rates go up and you decide to break an MVA contract to take advantage of a fixed annuity that offers the new rate, you’ll pay a bigger penalty than if you broke a book value contract.
The MVA triggers two penalties when you withdraw too much money (over 10 percent, in most cases) from your annuity during the surrender period. Typically:
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You have to pay a surrender charge (for example, equal to the number of years left in the surrender period)
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Your account value is adjusted
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Downward if interest rates have risen since you bought your annuity
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Upward if rates have declined
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Keep in mind the effects of interest-rate risk. Suppose you buy a $10,000 bond that pays 5-percent interest per year. Your bond has a face value of $10,000 and a yield (rate of return) of 5 percent. But then calamity occurs. The Federal Reserve’s Board of Governors raises interest rates to 6 percent. Immediately, the market price of your bond drops.
Why does your bond lose value when rates rise? Because no one wants to pay $10,000 for a bond with a 5-percent yield when he can buy a $10,000 bond with a 6-percent interest rate! Your 5-percent bond will fetch about $9,260 on the open market when 6-percent bonds are selling for $10,000. The important principle to remember is this: When interest rates rise, the market prices of existing bonds fall.