In the past, annuities have been misunderstood as complex investment vehicles. After all, they’re known for their high commissions and opaque fees. Furthermore, these commissions often line the pockets of salespeople. As a result, returns can be substantially eroded.
In recent years, however, a new breed of annuities has emerged: commission-free annuities. DPL Financial Partners, a leading provider of commission-free annuities, has sold more than $2 billion in no-load annuities, more than doubling its sales in 2022.
Let’s dive into what they are, how they work, and whether they can help you save for retirement.
What Are Annuities and How Do They Work?
If you are unfamiliar with annuities, they are financial contracts where you trade a lump sum or regular payments for a stream of income. With annuities, you can receive income over a set term or for the duration of your life. As a result, they are an appealing source of retirement income security.
Although annuities can be tailored to suit your needs, they’re complicated products with some pitfalls. Most notably, they’ve traditionally come with high commissions.
The commission depends on the annuity type and the total value of your contract. Most annuities, however, have higher commissions when they’re more complicated. In the case of a 10-year fixed index annuity, the commission ranges from 6% to 8%. An immediate annuity with a single premium typically carries a 1% to 3% commission.
It goes without saying that these commissions can incentivize salespeople to prioritize their earnings at the expense of your interests.
Understanding Commission-Free Annuities
The name says it all. A commission-free annuity, also known as a no-load annuity, eliminates the salesperson’s cut. It is common for these no-load annuities to offer:
- Lower costs. The cost savings are the most significant benefit. When you don’t have a commission eating away at your investment, your money has more time to grow.
- Higher returns are possible. As a result of lower costs, you may see higher returns over time.
- Transparency. Commission-free annuities often have simpler fee structures, making it easier to understand where your money is going.
- Interest alignment. Choosing a fee-only advisor ensures their recommendations are based on your best interests, not commissions.
- Control. Because you are not under pressure from commission-driven salespeople, you have more control over the purchasing process.
However, you may wonder how insurance companies profit without commissions. Several factors contribute to the answer:
- Fees. There are fees associated with these annuities, just like with mutual funds. Generally, they cover administrative costs and investment management fees.
- Mortality and expense risk charges. As part of the annuity contract, these tools assist the insurer in reducing the risk of overpayments.
In short, even commission-free annuities aren’t completely free. As such, returns can still be affected by surrender charges and administrative costs. Therefore, it is essential to carefully review the fee structure of any annuity you are considering.
The Role of Financial Advisors
Fee-only advisors are more likely to recommend commission-free annuities because they earn income solely from client fees. Their compensation model aligns with the client’s interests because they benefit from the client’s long-term success.
In addition to annuity products and advisor fees, underlying investment performance also influences the annuity’s cost.
Commission-Free Annuities: Worth It for Retirement?
Retirees are attracted to annuities because they provide a steady income stream and tax-deferred growth. However, even commission-free options can come with high fees and are complex.
Many retirees may be better off saving for retirement with low-cost index funds within an IRA. In addition to IRAs and 401(k)s, annuities can be considered by high earners seeking to maximize retirement contributions.
For potentially lower costs, consider annuities offered by companies like Fidelity or Vanguard.
Other factors to consider include:
- How much risk you are willing to take? It is generally less risky to invest in annuities, including commission-free ones, than it is to invest in stocks. But there are also fewer potential returns. If you don’t mind higher risk for potentially higher returns, annuities might not be for you.
- What you need to earn a living. If you’re looking for a guaranteed income stream in retirement, an annuity may be the right option for you. There are, however, other options to consider, such as dividend-paying stocks or rental properties.
- Your financial knowledge. Annuities can be complicated. An advisor, though, might be able to help you if you’re not familiar with annuities.
Additional Considerations
- Fees. Despite the lack of upfront commission, commission-free annuities still charge fees. Evaluate the annuity’s overall cost in comparison to other investment options.
- Surrender charges. You may have to pay surrender charges if you withdraw money early from an annuity. Before investing, make sure you understand the terms.
- Guaranteed income. Income guaranteed by annuities is not available with all annuities. Make sure you choose an annuity with this feature if it is an important part of your retirement plan.
- Tax implications. Annuities are subject to specific tax rules. You should consult a tax professional for more information on how annuities will impact your taxes.
The Bottom Line
Among annuities’ most prominent features is their ability to provide a steady income in retirement. However, they also have high commissions and costs. Although commission-free annuities are more affordable, it is important to understand all their associated fees.
This can’t be stressed enough. It is best to seek the advice of a fee-only financial advisor who can assess your financial goals and recommend appropriate options. The most effective way to protect your hard-earned money is to carefully consider all the costs and benefits of doing so.
FAQs
Precisely, what are commission-free annuities?
A commission-free or no-load annuity is an investment product that doesn’t require a sales commission. Instead of paying a portion of your investment to the salesperson, commission-free annuities pass these costs to you.
How do commission-free annuities work?
Insurance companies generate revenue from commission-free annuities by:
- Management and administrative fees
- Mortality and expense risk charges
In addition to the upfront sales commission, other fees, such as surrender charges and additional features, may still apply.
Are commission-free annuities safe?
Commission-free annuities, like any other financial product, have risks. Understanding the terms and conditions of the contract, including guarantees and penalties, is essential.
What are the downsides of commission-free annuities?
- Limited availability. A commission-free annuity may not be as widely available as a traditional annuity.
- Potential for complexity. Choosing the right commission-free annuity can be more challenging without personalized advice from a salesperson.
- Other fees. These annuities are commission-free, but surrender charges and rider fees may still apply.
How can I Choose a commission-free annuity?
- Understand your goals. Decide how much retirement income you will need and how much risk you are willing to take.
- Compare products. Compare commission-free annuities based on their fees, rates, and features.
- Consider your knowledge level. If you’re comfortable navigating the complexities of annuities, you might be able to find a commission-free annuity option.
- Seek professional advice. Although financial advisors are not required, they can offer valuable insight and advice.
Where can I find commission-free annuities?
Here are some places where you can find commission-free annuities:
- Directly from the insurance companies. Some insurers offer these products without the involvement of agents.
- Financial advisors. Some advisors specialize in commission-free or fee-based products.
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