Annuities are often marketed as a secure way to earn a retirement income. But do they live up to their hype? One major concern for investors is the frequently hidden costs associated with these products. You need to know what annuity fees mean before deciding based on your retirement goals.
In this blog post, we’ll cut through the jargon and explain what annuity fees mean, empowering you to make informed decisions about annuities.
What Are Annuities?
It’s important to understand what annuities are before diving into fees. An annuity is a contract between you and an insurance company. If you pay a lump sum or a series of payments, the insurance company will provide regular income payments for a specified period of life.
Generally, annuities can be divided into three categories;
- Fixed Annuities. In many cases, these types of investments come with a guaranteed payout and are considered low-risk.
- Variable Annuities. Your premium is invested in various sub-accounts, with payouts based on the performance of those investments.
- Indexed Annuities. Linked to a market index, these offer a balance between fixed and variable annuities.
Although annuities can be valuable retirement planning tools, their costs can significantly impact their value.
Types of Annuity Fees
Fees can significantly reduce your returns when you invest in annuities. The following are eight of the most common ones.
Commissions.
You typically purchase an annuity through an agent who helps the issuing company sell it to you. There is a good chance that this individual will receive a commission, just like other types of agents. Usually, the commission is built into the contract price.
“Commissions are different than fees. There are many complex types of annuities where a salesperson’s paid a high commission,” Rob Williams, managing director at the Schwab Center for Financial Research, told Annuity.org. “The person who’s buying them won’t see that. They’re not charged for it.”
Your commission may vary depending on the annuity type and contract value. More complex annuities typically have a higher commission.
A typical commission by annuity type;
- Single Premium Immediate Annuity: 1% to 3%
- Multi-Year Guaranteed Annuity (MYGA): 1% to 3%
- Deferred Income Annuity: 2% to 4%
- Fixed Index Annuity: 6% to 8%
For example, if you have an annuity with a $100,000 premium, your agent would earn $5,000 if they earned a 5% commission. This cost is usually included in the contract and is not an out-of-pocket expense for you.
Administrative fees.
Annuity companies usually charge administrative fees to cover maintaining your account. Depending on the value of your account, these fees can be flat rates or percentages.
A typical administrative fee is at least .30% of an annuity contract’s yearly value. On the other hand, fixed fees vary from $50 to $100 per year based on the product and company.
Mortality and expense risk charges (M&E Fees).
As part of its annuity contract, the insurance company assumes certain risks, which are compensated by M&E fees. Charges typically range between 0.5% and 1.5% of account value annually.
In the long run, these fees can reduce your overall returns, even if they seem minor.
Rider fees.
You can add riders to your annuity contract to provide additional benefits, such as guaranteed income or death benefits. Rider fees typically range from 0.25% to 1% of the annual account value for these benefits.
Surrender charges.
Surrender charges are often included in annuity contracts, making them important to consider. As a “lock-in,” this usually lasts 1 to 10 years.
Surrender charges apply to withdrawals from annuities before the surrender charge period ends — similar to a cell phone early termination fee (ETF). Due to their significant impact on your returns, these fees are intended to discourage early withdrawals.
Key considerations;
- Penalty-free withdrawals. Annuities usually allow a small percentage of the total value to be withdrawn penalty-free yearly. Although this provides some flexibility, it is also important to know the limitations.
- Required Minimum Distributions (RMDs). When you fund your annuity with qualified funds (like a 401(k), you’ll eventually be required to make Required Minimum Distributions (RMDs). According to the contract, these withdrawals are generally not subject to surrender charges.
- Market Value Adjustments (MVAs). Some contracts include an MVA provision. In periods of market volatility, this adjustment can significantly impact the value of your annuity. Before deciding on an MVA, you should fully understand how it works.
Over time, surrender charges typically decline from around 10 percent to zero percent.
Expense ratios.
Expense ratios represent the fees for managing underlying investments for variable and fixed index annuities. These fees generally range between 0.06% and 3% based on the underlying investment.
Rate spreads.
An insurance company’s rate spread is the amount it subtracts from any gains before applying interest to your annuity. The average spread for these products is around 2%. For instance, if your gain is 5%, you will get 3% after applying the rate spread.
Subaccounts incur fees and expenses.
Morgan Stanley says these fees apply to variable annuities and include;
- Management fees. A fee is paid to your investment advisor for managing your investments. It is similar to the management fee charged by a mutual fund.
- Trading expenses. The cost of buying and selling securities within the subaccounts.
- Administrative expenses. Costs associated with managing subaccounts.
An asset-based expense typically ranges from 0.15% to 3.26% annually per subaccount and can vary.
How Annuity Fees Impact Your Returns
Over time, annuity fees can significantly reduce your investment returns. For example, if your annuity earns 6% a year on average but 3% in fees, your net return is 3%. The difference can cost tens of thousands of dollars over 20 or 30 years.
Comparing Annuity Fees to Other Investment Options
Comparing annuities’ fees with other investment options, such as mutual funds, ETFs, or index funds, is essential when evaluating them. Although these alternatives may not offer the same guarantees as annuities, they often come with significantly lower fees, potentially resulting in higher returns.
Tips for Managing Annuity Fees
If you decide an annuity is right for you, you can minimize the impact of fees;
- Shop around. In the world of annuities, not all are created equal. As a result, compare products from different providers to find one with lower fees.
- Negotiate. Occasionally, you can negotiate lower fees, especially with high-value contracts.
- Understand the fine print. You should carefully review the annuity contract to ensure you know all the fees and charges.
- Consider fee-only financial advisors. Work with a fee-only advisor who can help you evaluate annuities without the conflict of interest from commission-based sales.
- Evaluate the need for riders. Riders should only be considered if they provide significant value in your specific situation.
Are Annuities Worth the Cost?
Whether an annuity is worth the cost depends on your personal financial goals, risk tolerance, and retirement needs. Annuities sometimes outweigh the fees because they provide income stability and guarantees. Alternatively, lower-cost investment options may be more appropriate for some investors.
Conclusion
Despite their value as a retirement tool, their fees can significantly impact annuities. You can make an informed decision by understanding the types of fees associated with annuities and their potential impact on your returns. If you are considering an annuity, compare your options, read the fine print, and seek professional advice.
FAQs
How do annuities work?
Investors can make periodic payments or lump sum deposits to have income in the future with annuities. The investor can choose a fixed or variable return, along with immediate or deferred income. Over time, the money set aside grows.
There are, however, fees involved, such as commissions and taxes. Moreover, early withdrawals come with penalties.
What are the potential consequences of high annuity fees?
- Reduced returns. If you invest in annuities with high fees, your overall return will be significantly reduced.
- Lowered income in retirement. As fees eat away at your principal, you may have less income available in retirement.
- Difficulty withdrawing funds. If you need your money before the surrender period ends, you may have difficulty accessing it due to high surrender fees.
How can I find out about the fees associated with an annuity?
- Read the annuity contract carefully. In this document, you will find a detailed breakdown of all the product’s fees.
- Ask your financial advisor. In addition to explaining the fees in detail, they can help you determine how they will impact your returns.
- Compare fees from different insurance companies. Consider the lowest fee annuities that still meet your needs when shopping around.
Are there any ways to minimize annuity fees?
- Choose a simpler annuity. A lower fee is usually associated with annuities with fewer features and riders.
- Consider annuities with lower expense ratios. You should look for annuities with lower administrative costs, mortality, and expense risk charges.
- Negotiate with your annuity provider. Negotiating some fees is possible, especially if you’re investing a lot.
- Shop around. Before choosing an annuity provider, compare their fees.
- Consider fee-based annuities. Instead of commissions, your financial advisor pays for these annuities.
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