by Justin Setser, CTFA, CFP®, MBA – Vice President & Relationship Manager

Over the past couple of years, as I have met with clients and prospects, I have noticed that a lot of people own variable annuities. I do not claim to be a variable annuity expert, however I have learned more about them over the past couple of years as I’ve worked with people who currently own them. Variable annuities can be complex, hard for clients (and financial professionals) to understand and the fees can add up quickly. There are many different types and varieties of annuities but for the purposes of this article we will focus on variable annuities.

What is a Variable Annuity?

As defined by the U.S. Securities and Exchange Commission, a variable annuity is a contract between a person/s and an insurance company. It serves as an investment account that may grow on a tax-deferred basis and includes certain insurance features, such as having the ability to turn your account into a stream of periodic payments. A variable annuity contract can be purchased by making either a single purchase payment or a series of purchase payments.

A variable annuity offers a range of investment options. The value of the contract will vary depending on the performance of the investment options chosen. The investment options for a variable annuity are typically mutual funds (sub-accounts) that invest in stocks, bonds, money market instruments, or some combination of the three.

Each variable annuity is unique. Most include features that make them different from other insurance products and investment options. Keep in mind that the features offered by variable annuities come at a cost.
Clear as mud? Trust me, you aren’t alone!

Fees and Expenses

The fees associated with a variable annuity can make them an expensive product to own. Fees can vary widely from product to product, therefore taking the time to understand them before buying a variable annuity is very important.
Below are some common variable annuity expenses:

Insurance Charges

These are known as mortality and expense (M&E) fees and administrative fees. These include insurance guarantees in the annuity, and the selling and administrative expenses of the contract. The (M&E) fees can range from .50% – 1.50% and the administrative fees can range from .10% – .30% per year.

Investment Management Fees

These fees are assessed on the investment options (sub-accounts) within a variable annuity, and are similar to management fees on mutual funds. It’s important to check the annuity prospectus in order to have a good understanding of the underlying investment options (sub-accounts) and their corresponding investment management fees. These fees can range from .25% – 2.00% per year.

Rider Fees

Riders are optional guarantees and are available in some annuities. For example, a death benefit rider may be available (at an additional cost) to ensure the owner’s heirs receive at least the principal that was invested upon the owner’s death (minus any withdrawals). Some riders are not optional and may be a standard cost associated with the annuity contract. Depending on the extent of the benefit, rider fees can range .25% – 1.15% per year.

Surrender Charges

Many policies pay an upfront commission to the person who sells the policy. A surrender charge is put on the variable annuity policy, so that if cancelled early, the insurance company can recoup the commission it paid out. Surrender charges often decline gradually over a period of several years. For example, a 7% charge might apply in the first year after a purchase payment, 6% in the second year, 5% in the third year, and so on. Typically, after six to eight years (or sometimes longer), the surrender charge may no longer apply. Be sure to ask for details on surrender charges to ensure there is enough flexibility in the contract.

Should I Keep My Variable Annuity?

There are a lot of things to consider before purchasing (and surrendering) a variable annuity. A list of some possible considerations when surrendering a variable annuity might include: Is the annuity in an IRA or is it a non-qualified annuity? How much gain/loss is there in the annuity? What benefits would be foregone by leaving the annuity? What other sources of income does the owner have? Would there be surrender charges?

An educated decision can make all the difference when purchasing or surrendering a variable annuity. If you have questions about an annuity, are considering surrendering an annuity, or would like a professional review of an annuity please reach out to the team of advisors at Central Trust Company.

Works Citied