I’ve received quite a few questions recently about variable annuity fees and performance. I’ve also had several clients, family members, and other folks ask me to review their annuity account statements.
The questions range from “How come my account isn’t growing?” to “I don’t have any idea how this thing works or what fees I’m actually paying. Can you help?”
Unfortunately, because these products are so complex, it’s nearly impossible to understand how the annuity is structured or what fees you’re paying without digging into the prospectus (which is typically 300 to 800 pages of financial jargon).
For example, here’s a link to an annuity I’ve reviewed before with a 720 page prospectus: Jackson Perspective II Fixed and Variable Annuity
As complex as these products are, they are also very commonplace. There was nearly $143 billion in variable annuity sales last year alone. Fixed annuities took in another $78 billion.
All of this to say, there is a ton of money invested into products for which the buyers have very little idea of what they are actually buying.
High Commissions and Variable Annuity Fees
One of the reasons why these numbers are so large is because annuities are highly profitable, both for the insurance companies who distribute them and the sales people who sell them.
The commission on a variable annuity often ranges from 5% to 10% of the amount invested. Thus, assuming a commission of 7.5%, investing $500,000 into an annuity would net $37,500 in commissions.
To make this up front commission possible, there are a whole host of fees you pay on an ongoing basis. These fees make the typical variable annuity one of the most expensive investments on the market.
To help you understand all of the fees, charges, and expenses you might be paying, I’ve put together this guide so you can review the annuity you currently own or the one someone might be trying to sell you.
If you’d prefer, I’m also happy to review your annuity for you. Just give me a call at (303) 500-3245 or fill out this contact form.
What Variable Annuity Fees am I Paying?
As I mentioned above, the prospectus for a typical variable annuity is several hundred pages long. One of the reasons is because variable annuities are so complex and contain so many hidden fees.
And instead of summarizing these fees on a single, easy to read page, most insurance companies bury them in the prospectus. This is convenient for them because they know that very few potential buyers will ever read the prospectus.
What’s worse, however, is that I can almost guarantee you that the person who sold you the annuity doesn’t even fully understand how it works. He or she just knows that the product pays a big commission and has “features” that they can sell.
If you’re reading this, kudos to you for taking the time to actually understand what you bought and how it works. To get to the bottom of what you’re paying, follow these four steps:
Step 1: Get a Copy of your Most Recent Statement
The insurance company that manages your annuity contract should provide you with a monthly or quarterly account statement. Your statement may or may not include the following details:
- Contract number
- Name of the annuity product
- Contract issue date
- Annuity type (qualified/IRA or non-qualified)
- Current account value
- Surrender value information
- Sub-account investments (or linked index if it’s an equity-indexed annuity)
- Benefits and riders purchased
If you don’t have a recent statement, you have a couple options:
- Log in to the insurance company’s web site and download a copy
- Call the 800 number on an old statement and request a current statement
Step 2: Find the Prospectus for your Specific Annuity
In order to pinpoint the exact fees that you’re paying for your variable annuity, you need to track down the prospectus for your specific product. Since you have your statement in hand, go to the annuity provider’s web site (or Google) and search for the exact name of your annuity.
If you can’t track down the prospectus or your statement doesn’t specify the product you purchased, you can call the annuity or insurance company and ask them to send you a copy (just give them your contract number when you call). Be sure to ask for the prospectus in electronic form, as it’s much easier to navigate through it using keyword searches than flipping through 500 pages.
Once you have the prospectus, you’ll want to go to the section that details the charges, fees, and expenses for your annuity. It’s typically called something like “Summary of Contract Fees and Charges” or “Contract Charges.”
Step 3: Review your Expenses
Almost every variable annuity will have charges and fees that fall into the general categories I’ve outlined below. The exact language that each insurance company uses will vary, but you should be able to figure things out by reading through the section on charges carefully.
Mortality and Expense (M&E) Charge (typically 0.50% to 2.00% per year): The M&E charge is an insurance-related expense that you pay for the death benefits associated with the annuity. This charge also goes to compensate the insurance company for the risks they bear for other obligations that may arise during the contract period (e.g. longer than expected income payments after the account is annuitized).
Administration Charge (typically 0.05% to 0.25% per year): The Administration Charge covers expenses incurred by the annuity provider associated with servicing and maintaining the contract. Sometimes this fee is lumped in with the M&E charge as part of an overall Insurance Charge.
Annual Maintenance or Contract Charge (typically a flat fee of $25 to $50 per year): In addition to the Administration Charge, annuity companies commonly charge a flat annual fee for administrative expenses called an Annual Maintenance Charge or an Annual Contract Charge. Sometimes this fee is waived for larger accounts.
Riders (vary depending on the specific rider chosen, but typically 0.30% to 3.00%): Every annuity company offers a whole host of optional benefits and riders that can be added to an annuity contract. These include includes lifetime benefits, such as guaranteed income, guaranteed withdrawal, or guaranteed return options. Insurance companies also commonly offer a range of different death benefits. Each rider you choose adds to the annual charges you pay.
Sub-Account Fees (typically 0.50% to 2.00% per year): Sub-Account Fees are the expenses you pay on the underlying investments within the annuity. They are similar to the expense ratios for mutual funds or ETFs. However, very few annuity providers offer low cost or index sub-account investment options. Most of the investment choices are expensive, actively managed mutual funds.
Surrender Charges (start as high as 10% and decline to 0% over time): The single worst part about variable annuities is that they lock up your money for five to ten years with Surrender Charges. These charges are designed to discourage you from withdrawing funds from the annuity or canceling your contract. Surrender Charges are also used to reimburse the annuity company for the big commission that they paid to the person who sold you the annuity at the outset.
Surrender Charges are tied to a surrender term schedule, whereby the Surrender Charge starts high and then declines over time. If your annuity is still within the surrender period, you would have to pay the Surrender Charge in order to get out of the annuity.
Step 4: Add Up All the Charges
Now that you’ve located all your fees, it’s time to add them all up. As an example, here are the charges from a recent variable annuity I looked at:
- M&E Charge: 1.70%
- Administration Charge: 0.15%
- Annual Maintenance Fee: Lesser of $50 or 2.0%
- Highest Daily Income Option: 0.95%
- Sub-Account Fees: 1.13%
All-In Annual Fees: 3.93% (plus $50 for good measure)
To put this number in perspective, a typical low cost portfolio that I recommend has annual expenses of around 0.25%. So we’re talking fees that are more than 15 times as high.
On top of those fees, if this particular investor wanted to get out of the annuity or exchange it for a lower cost option, they would have to pay a surrender charge of 6.0% on the amount they had invested.
Unless you’ve owned your annuity for at least three to five years, you are almost certainly within the surrender period as well.
I hope this guide helped you to get your arms around the fees you’re paying for your annuity. Although not all annuities are bad, the fees and restrictions on most variable annuities make them one of the worst products on the market in my opinion.
The only variable annuities I would consider are the low cost versions without all of the riders offered by TIAA-CREF, Jefferson National, or Vanguard. And even then, variable annuities are only appropriate in certain (less common) situations.
On the other hand, sometimes very simple annuities, known as single premium immediate annuities (SPIAs), can be great retirement tools. However, very few sales people recommend SPIAs as they don’t carry the big commissions of their variable cousins (although they are hardly related).
Ultimately, if you find out that you are paying more fees than you realized, you might want to consider either canceling the annuity or exchanging it for a lower cost option with another company. Before you do, be sure to consider your specific situation and talk to a fee-only financial advisor who can help you understand your choices.