Hopefully, you are now a little more knowledgeable when it comes to the different types of annuities. Next up? Learning all about the fees that are associated with annuities.
Regardless if you buy a variable annuity or fixed annuity, there are different fees charged on these different types of annuities. How are they determined? Well, it comes down to the purpose of the contract terms that you agreed to when you signed the contract.
“Generally, variable annuities include an underlying investment (e.g., mutual fund) and charge explicit fees,” clarifies the folks over at Fidelity. “Fixed annuities offer either a fixed rate of return or a guaranteed income stream, which reflects the company’s expenses and profit margins, rather than having explicit charges that you typically find in variable annuities.”
When it comes to indexed annuities, things go in a different direction. In particular, “limiting returns through factors such as participation rates, spreads, and caps.”
While it’s not feasible for you to become an annuity expert, you should at least familiarize yourself with the most common fees that will be applied to your annuity contract.
General Annuity Fees and Expenses
Let’s be frank. Annuities can be expensive. It’s actually one of the biggest criticisms against buying an annuity. At the same time, not all annuities have high fees.
“Some investment companies sell annuities without charging a sales commission or a surrender charge. These are called direct-sold annuities because unlike an annuity sold by a traditional insurance company, there is no insurance agent involved. With the agent out of the picture, there is no need to charge a commission. Firms that sell low-cost annuities include Fidelity, Vanguard, Schwab, T. Rowe Price, Ameritas Life, and TIAA-CREF.”
We’d also be remiss if we didn’t mention that generally, the more complex the annuity, the higher costs you can expect. But, before we go too much further, let’s run down the most common annuity fees and expenses.
Immediate Annuity Fees
When it comes to immediate annuities, there aren’t traditional fees. Be aware, however, that the annuity owner will take a reduction in an income distribution amount when there’s a more favorable payout. You can also anticipate commissions on single premium immediate annuities, which we explain in greater detail shortly.
Deferred Income Annuity Fees
There also aren’t fees affiliated with deferred annuities, aka Longevity Annuities. But, as an annuity owner, the income distribution amount will be reduced when the payout swings in your favor. And, there are also commissions associated with this type of annuity.
Fixed Annuity Fees
With Fixed Annuity contracts, fees will come in the form of an interest rate reduction.
Fixed Index Annuity Fees
If you own a fixed index annuity, you are responsible for annuity rider fees. These are optional features that you can add to your annuity. Examples include enhanced death benefits or higher cap rates. It’s not uncommon for fees to cost up to 1.75 percent of the account value annually. But, this will depend on the exact benefit.
An example of this would be an annuity company that offers an optional upsell. Purchasing this rider will allow for more potential upside in your contract, as opposed to the standard non-fee option.
A word of caution though. Always double-check the fees associated with fixed index annuities. Some riders or benefits are “built-in.” As such, this will require you to pay an annual fee — regardless if you want the rider or benefit or not.
Variable Annuity Fees
Out of all the annuity types, variable annuities can get rather expensive. The reason is that you’re going to have to pay higher fees with variable products. That may sound unfair. However, variable annuities are not insurance products. Rather, they are investment products.
With that being said, here are the standard investment management fees you’ll most likely have to pay if you own a deferred variable annuity investment.
- Mortality Expenses (M&E): In short, M&E will provide death benefits to your heirs. These investment fees can cost up to 1.5 percent of your account value each year.
- Administrative Fees: Don’t be caught off guard by this service fee. Expect to pay up to .30 percent of the account value annually to maintain the ownership of your contract.
- Investment Expense Ratio: You’ll be charged an investment advisory fee for choosing the various stocks and bonds in your variable annuity, aka sub-accounts. Plan to pay up to 2 percent of the total value of your annuity annually.
- Guaranteed Lifetime Withdrawal Benefit: This income rider fee is similar to an index annuity’s income rider. You can expect to pay up to 1 percent of the account value annually.
- Enhanced Death Benefit Riders: An optional estate planning rider you can purchase if you want to protect your beneficiaries’ investment. The cost can be hefty and is usually up to .50 percent of the account value annually.
Long Term Care Annuity Fees
A long-term care annuity is a deferred fixed annuity specifically designed to help pay for long-term care costs. It’s similar to life insurance except that it will grow tax-free. If you want all the bells and whistles, this can get pricey. These charges are typically withdrawn from the account value annually.
The Annuity Fees You Need to Know About
In addition to the fees listed above, it’s also important to know what you’re paying for. While these should be spelled out in your contract, some annuity fees are hidden or not clearly defined. As such, here are the costs that you may find linked to your annuity.
Administrative Annual Fees
These fees were previously mentioned, but they deserve to be discussed in further detail. After all, these are the most conventional fees linked with an annuity. Basically, an administrative fee is a baseline charge that lets you maintain ownership of your annuity contract. In most cases, these fees can help cover items like account services, record-keeping, and basic management of the annuity.
Usually, administrative fees are charged as a percentage of your annuity’s total value. However, you may be charged on a flat-rate basis. For the latter, rates most likely will not exceed 0.30 percent of your contract’s value.
What if your provider uses a flat fee? If so, rates can range anywhere from $50 to $100. But, it’s not uncommon for an annuity company to waive your administrative fee. The catch? Your contract must be larger than a predetermined amount.
We’ve also briefly discussed annuity riders. However, annuity riders also need to be highlighted. Mainly as they can customize your annuity in order to supercharge it. Moreover, annuity riders are available for every type of annuity.
Some of the most common examples would be;
- Guaranteed withdrawal benefit rider allows you to access your money either through a guaranteed lifetime withdrawal benefit (GLWB), and a guaranteed minimum withdrawal benefit (GMWB).
- Lifetime income benefit rider (LIB) promises that you’ll receive regular income payments from the annuity.
- Death benefit rider guarantees that your heirs will receive at least the amount of the annuity premium.
- Long-term care riders can help accommodate the future cost of long-term care.
- Cost of living adjustment (COLA) rider will increase your monthly payments based on a measure of inflation.
- Refund or return of premium rider is similar to a death benefit rider
- Guaranteed minimum income benefit rider (GMIB) ensures a specific income payment.
- Guaranteed minimum accumulation benefit rider (GMAB) guarantees that the minimum amount you’ll receive will be the dollar amount invested in the contract. Or, at least the gain in the value of the contract.
- Impaired risk rider will increase your payments since you health-related condition that will shorten your life.
- Commuted payout rider lets you withdraw a lump sum from your annuity.
If you add any of these riders to your annuity, it could affect your contract’s payout and income payments. And, while optional, adding them to your contract will cost you additional fees that can range from insignificant to expensive.
Commissions with Annuities
There’s no way to avoid these fees with most annuities companies. Whether you like it or not, all annuity types come attached with commissions. Often these are built into the price and paid to the salesperson who sold you the annuity. However, there aren’t always highlighted in the contract.
Most of the time, these are also known as trailing commissions and are paid annually. Commissions can be anywhere in the vicinity from 1 to 10 percent of the total value of your contract — depending on the annuity type.
Usually, the more complex the annuity you have, the higher the commission you’ll pay. And, the reverse is true as well. A simpler and more straightforward contract means the lower the commission.
FYI, Wells Fargo announced In 2014, that it would only include fixed-indexed annuities that limited commissions to 4 percent. And, commissions will vary depending on the annuity type.
- As the least complex annuity type, fixed annuities have relatively low commissions. Furthermore, fixed index annuities can have low surrender periods — sometimes as low as four years. However, most have 10 years with a surrender charge. If that’s your annuity, the commission on a 10-year fixed index annuity can land somewhere between 6 to 8 percent.
- For single premium immediate annuities, commissions often range from 1 to 3 percent.
- Deferred income annuities, also known as longevity annuities, can charge commissions in the range of 2 to 4 percent.
- Multi-year guaranteed annuities (MYGAs) usually have no fees. Another perk is that the surrender periods are between three to ten years. And, commissions on MYGAs are typically between 1 and 3 percent.
Does your annuity invest in a mutual fund? Well, most annuities do. So, don’t be surprised if you’re charged management fees.
Investment Expense Ratios
If you’re forgotten, your money is tied to an underlying investment when you buy a variable annuity. For instance, let’s says that your assets track the performance of mutual funds, ETFs, or index funds. There will be an expense ratio carried with each of these types of funds.
But, what exactly is an expense ratio? In a nutshell, this reflects the annual cost of owning the fund. It’s often deducted from the assets that you’ve invested in the fund. In short, this is the indirect cost of owning a variable annuity. These rates will vary, but they most likely will not exceed 2.5 percent.
Mortality and Expense Risk Charges (M&E)
We can’t stress this enough; an annuity is an insurance product. It is not considered a security product like a stock or a bond. As such, insurers are responsible for taking on this risk. And, in exchange for this, they’re compensated through a commission known as a mortality and expense risk fee
This fee guarantees that the cost of providing the annuity will never change — regardless of your mortality risk or life expectancy changes. Usually, these fees range from 0.50 percent to 2 percent of your contract’s value.
Annuity Penalties Fees
As a refresher, if you are under age 59½ and need to make a withdrawal, the IRS will get 10 percent. Additionally, the contract writer will also request a surrender charge. Typically, this is between 5 percent and 15 percent. However, this charge will decrease the longer that you hold the annuity.
Let it be known that you can not borrow against your contributions. However, Uncle Sam is gracious enough to allow the transfer of funds to another insurance company — often without penalty. It’s in your best interest to let your accountant take care of this for you to avoid trouble.
And, you probably should have an emergency fund so that you do not have to pull money out from your annuity.
There may come a time when you decide to sell some, if not all, of your ownership in an annuity in exchange for cash. This is permittable. But, just know that you’ll probably have to pay a surrender fee. These fees only apply when you make a withdrawal before your regular scheduled payments begin.
How much will a surrender fee cost you? That really depends on the terms of your annuity contract. For example, you have a 10-year contract and decide to sell your annuity four years in. The insurance company could charge a higher surrender fee than if you waited until you’re closer or have reached the 10-year mark.
Most insurance companies use a declining fee schedule in regard to withdrawal charges. In other words, the surrender charge will decrease annually and will eventually disappear.
Tax on Annuity Beneficiaries
What if you want to leave your mutual fund to your kids? If so, you’re allowed by the IRS to take advantage of a step-up valuation, or the market price of the securities, when you make the transfer. Unfortunately, you can’t do this with annuities. That means that your beneficiaries will be charged taxes on any gains that your annuity has made. You may be able to make reduce the severity with estate planning.
Tax Opportunity Cost
If you’ve invested after-tax dollars into an annuity it will grow tax-deferred. However, these benefits will not be able to compete with the pretax dollars you’re contributing to your 401(k). In other words, you should only invest in an annuity after you’ve maxed out your 401(k) contributions.
These fees go to the people who take the actuarial risk on the benefits.
Other charges that you may have to pay as an annuity owner include contract fees, distribution charges, redemption fees, and transfer fees.
What is an Annuity Premium?
In addition to the above fees, there’s also the annuity premium. Without paying for this, you won’t be able to buy into your contract. The required premium amount varies and is based on factors like the value of the annuity, as well as the annuity type. Moreover, there also differences in how you pay the annuity premium.
Generally speaking, the different types of annuity premiums include;
- Initial investment. This is straightforward. If you want to purchase a $10,000 annuity, then you would write a check for that amount to get the contract started.
- Additional or ongoing premiums. If the contract allows this, you can make additional payments into your annuity. You may be able to do this through automatic monthly transfers via ACH or you could manually write a check.
- Single-premium strategy. Here is when you make one annuity premium payment, or one investment, with a lump sum of money. You can do this by rolling over an old 401(k) or IRA.
Since every insurance company established its own minimum initial premium rules, we can’t give you an exact figure. In most cases though, these minimum requirements usually don’t exceed $100,000, with the lowest amount being around $2,500.
Final words of advice; always dig into your annuity contract.
We can’t stress this enough, annuities aren’t cheap. Even worse, the annuity company isn’t always transparent about the costs and fees that come with it. As such, don’t treat your annuity contract the lengthy terms of service that you always agree to without reading. You need to go through the annuity carefully and always read the fine print.
If you don’t understand the contract or don’t see it clearly stated, asks. For example, if you’re working with a fee-only advisor, they have a fiduciary responsibility to be transparent — they also don’t earn a commission. If you’re working with a commission-based broker, ask them how much of a commission they’ll be receiving.
It’s also advised that when you have a clear understanding of all the costs and fees involved, write them down and ask the agent to sign the document so that there are no surprises down the road. For example, charging you a higher commission fee than previously agreed upon.
Annuity Fees You Need to Know About
Frequently Asked Questions About Annuity Fees
What are common insurance charges?
These are also commonly known as mortality and expense (M&E) fees and administrative fees. Their purpose is to “pay for insurance guarantees that are automatically included in the annuity, and the selling and administrative expenses of the contract.”
What are investment management fees?
“These are assessed on the investment options within variable annuities, and are similar to management fees on mutual funds,” notes Fidelity. You’ll want to double-check “the annuity prospectus for any underlying funds to learn how much you might pay for investment management fees.”
What are common surrender charges?
It’s not uncommon for insurance companies to limit the amount of penalty-free withdrawals you can take out during the initial years of a contract. As such, expect a “surrender charge on any withdrawals above that preset limit.” Fidelity warns though that, these charges can be hefty and imposed for an extended time period. It’s definitely worth it to “ask for details on any surrender charges to help ensure that you have enough flexibility”.
What is a rider fee?
These are optional guarantees that are available in certain annuities. One example of this would be a death benefit rider. For an additional cost, this ensures that your heirs will at least receive the principal that you invested upon your death (minus any withdrawals). However, “some riders are not optional and maybe a standard cost associated with the annuity contract.”
Typically, variable annuities come with insurance charges, underlying investment fees, surrender charges, flat contract fees, and riders if applicable. These fees are deducted from your annuity contract balance. With fixed annuities, you may only have to be concerned with surrender charges since fees are embedded in the stated rate or guaranteed income amount.
- What Is an Annuity?
- The Difference Immediate Annuities and Deferred Annuities
- How does an annuity work?
- The Benefits of a Deferred Annuity
- The Benefits of an Immediate Payment Annuity
- What Is a Variable Annuity?
- What Is a Fixed Index Annuity?
- What Is an Indexed Annuity?
- A Brief History of Annuities
- Will Annuities Recover?
- Money for Today or the Rest of Your Life?
- Are There Any Other Types of Annuities?
- Become Familiar With Annuity Fees
- What Are Your Payout Options?
- Weighing the Pros and Cons of Annuities
- Is An Annuity Right For You?
- How To Measure Your Annuity
- Understanding Annuity Formulas
- Annuity Calculators
- 5 Questions To Ask Before Buying An Annuity
- Annuity Glossary Index