Variable Annuities as Insurance Products
Annuities are insurance products, so take the time to understand what it is that you are insuring. Think of the annuity fees like an insurance premium. You are paying the insurance company to bear the risk. They may be insuring your future retirement income by providing a guaranteed withdrawal benefit rider, or insuring a specific amount of death benefit to go to your heirs, or insuring a minimum return. Make sure you understand the benefits you are purchasing.
The 5 Categories of Annuity Fees
The fees associated with a variable annuity can make them one of the most expensive products that you can purchase. These various fees can fall into five categories. You should take the time to understand all the following fees and charges before you buy a variable annuity product.
Mortality Expenses (M&E)
It is a fee charged by the insurance company to provide you with a death benefit (often just a guarantee to pay out to your beneficiaries at least what was put in). This variable annuity fee can range from .50 – 1.5% of the policy value per year.
Administrative expenses
Many variable annuity policies have a separate administrative fee to cover the cost of mailings and ongoing service. This fee can range from .10 - .30% of the policy value per year.
Investment Expense Ratio
Inside a variable annuity, the underlying stock and bond investment choices, called sub-accounts, will have an investment management fee, which can range from .25 – 2.00% of the value in that account per year.
Additional Cost of Riders
Riders are extra features on your variable annuity policy that provide you with additional guarantees or death benefits. Depending on the extent of the benefit, riders can cost .25 – 1.00% of the policy value per year.
Surrender Charges
Many policies pay an upfront commission to the person who sells the policy to you. A surrender charge is put on the variable annuity policy so that if you cancel the policy early, the insurance company can thus recoup the commission they had to payout. Surrender charges can vary from 3 years to 15 years in length, which limits your flexibility. If your circumstances change, such as a divorce, you may not be able to split your account without paying the surrender charges.
Fees Impact Your Returns
Within the variable annuity product, there exist the same investment options that you may have outside of that product. In other words, the same funds and other investments offered under the annuity may be available from other providers. This means if you are paying 3%—or more—each year in fees, your annuity has to earn back all the fees before you start seeing a respectable return.
Salesperson Compensation
In addition to understanding variable annuity fees and expenses, find out how much the person you buy the annuity from will make on the sale. Don’t accept an answer like “My company pays me.” The way someone answers this question will tell you a lot about the type of person you are dealing with. An insurance company may pay commissions as high as 5 to 9% of the amount you invest. These financial salespeople may not have any other solutions to present to you, and this is not acceptable. If the recommendation was made after someone put together a holistic financial plan for you, this is a good sign. If no plan was made, be cautious. Before you purchase anything from a financial salesperson who will receive a commission, you may want to talk to a fee-only financial advisor. A fee-only advisor cannot receive a commission for selling investment or insurance products. You should also check out the SEC’s consumer guide on what you should know about variable annuities.
