By Laurence Greenberg, CEO, Jefferson National
In today's environment, "fee transparency" is the mantra for all kinds of financial products. Unfortunately, it’s been slow in coming to variable annuities.
Some real progress has been made with simple, transparent, low-cost products. But until greater consumer value is widespread, here's a primer on how to peel away the layers of an annuity's fees so you can weigh the benefits of what you’re getting against what you’re paying.
Generally, variable annuity owners are subject to two levels of fees: insurance-related fees from the issuing insurance company, and fees charged for the underlying investment options inside the VA. Most of these fees are asset-based—so the more you invest and the more your account value grows, the more you pay in fees. Other fees are driven by a transaction or time period, like annual service charges or additional trading fees.
PEELING BACK INSURANCE CHARGES
Most variable annuities get criticized for the insurance-related fees that drive costs up and performance down. On the typical VA, these combined insurance charges average 1.35% per year according to Morningstar.1 Here's what to look for:
Mortality and Expense (M&E): Most, but not all, annuity issuers assess M&E charges. According to Morningstar, this asset-based charge averages roughly 1.2%.1 For most annuities, this fee covers the basic death benefit guarantee, the promise that annual insurance charges won't increase, and the ability to annuitize at a guaranteed lifetime payout option down the road at the rates specified in the contract.
Because this is an asset-based fee, these costs increase as your investment grows. For a $100,000 annuity, the owner may pay around $1,200 in M&E fees; for a $250,000 annuity, the owner pays around $3,000.
With the growing popularity of ETFs in recent years, and with capital gains taxes at an all time low, to some investors this kind of M&E may seem like a high price to pay for a tax-deferred VA. So if tax-deferral is one of your objectives, it may benefit you to look for low-cost, or flat-insurance fee VAs.
Death Benefit Riders: All variable annuities have basic death benefit protection: a guaranteed return of the current account value or some portion of the initial premium if the annuity owner dies before payments begin. Now, though, more than 90% of all annuities offer an optional enhanced death benefit through the purchase of a death benefit rider.2
So if you added this rider for an extra 50 basis points a year on a $500,000 annuity, it would cost an extra $2,500 a year on top of the $6,000 M&E. Now both of those annual fees are chipping away at the returns of the underlying funds. If you’re insurable, a term life policy may be more cost-effective.
Living Benefit Riders: Many annuities also offer options that guarantee an enriched income stream in the future—but at a price. Annual fees for these riders typically cost an additional 1% to 3% per year or more.2
Here's another thing to consider. While annuities grow tax-deferred, annuity income benefits are taxable. So that enhanced benefit has a bigger tax bite. If you are looking to lock in additional future income, tax-free bonds may be a better alternative—providing more tax-advantaged income in the future, without annual fees.
Surrender Charges: Most typical VAs will pay a sales rep a commission of 5% to 7%, or more. Then to ensure that the issuing company can recoup their commission, these VAs impose a surrender charge. The surrender charge is an asset-based fee that may start as high as 7%, but will decrease to 0% over the course of the surrender period, which is typically the first 5 to 7 years of your contract. The surrender charge helps the issuing company to defray the commissions paid to its salesperson if the annuity does not stay on the books—and it can keep you locked in for years, unless you are willing to pay this penalty. Be sure to check your contract to find out whether surrender charges apply.
“No-Load” VAs do not pay a commission to a salesperson, so they do not have a surrender period or a surrender charge.
Annual Policy Fees. Many VAs charge a nominal policy fee, such as $25 a year. One more item that adds to your costs.
EVALUATING INVESTMENT FEES
Inside your variable annuity, you will find a selection of underlying funds, also known as sub-accounts or investment options. These underlying funds will charge annual asset-based fees which may vary widely—averaging from 0.6% for basic money market funds to 2.3% for bear market domestic stock funds.2
The annual fees charged for your underlying funds cover the cost of professional third-party money management—such as fundamental research, ongoing monitoring and allocation rebalancing. These annual fees may also include 12b-1 fees, which may pay for marketing and distribution.
Some companies allow free, unlimited trading of funds. Some will limit the number of free trades in a year by assessing a transaction-based fee. While a transaction fee may not be an issue if you are practicing a buy and hold strategy, it may be very costly if your variable annuity assets are actively managed. So be sure to know the trading policies of your annuity carrier.
WHAT YOUR STATEMENT DOESN’T STATE
Here's a little-known fact: Fees are not explicitly reported on variable annuity statements. All you will see is performance after fees have been deducted. So there's no annual reminder of what you are paying for, or what it costs you in terms of performance.
The best way to deconstruct the fees for any variable annuity is to read the prospectus. Then, ask yourself or your financial advisor these three key questions:
1) Does the annuity's long-term tax deferral match your financial objective?
2) Do death benefit and living benefit riders offer worthwhile guarantees--at a good value?
3) If a change is warranted, have your surrender charges expired?
The Bottom Line: The right variable annuity can still offer an attractive value for many investors, and can maximize the power of tax-deferral to help you accumulate more and reach your retirement goals faster—but only if it's not bogged down with excessive fees.
Laurence P. Greenberg is President and CEO of Jefferson National, which developed Monument Advisor, the first flat insurance fee variable annuity. See the impact fees and charges may actually have on your savings by taking the challenge at http://www.annuityrescuecenter.com/. For more information or to receive a prospectus, visit http://www.jeffnat.com/ or call 1-866-WHY-FLAT (866-949-3528).
1 Morningstar® data as of 12/31/07.
2 2007 Annuity Fact Book, National Association of Variable Annuities.
- Yield on Cost Matters
- Dividend Investing Resources
- Dividend Aristocrats List for 2009
- When to sell my dividend stocks?
- Best CD Rates
Thursday, March 26, 2009
By Laurence Greenberg, CEO, Jefferson National
I try to assemble my dividend portfolio by mixing three distinct types of dividend growth stocks. The first group consists of higher yield...
Ben Graham is one of the most successful investors of all time. He is the father of value investing , and the mentor of super investor Warre...
After scooping up some shares in 3M (MMM) last week, I didn’t expect to make more purchases this month. After all, April is usually an expe...
My favorite saying is that " The best time to plant a tree is 20 years ago. The second best time is today ." This is why I am care...
I expect that sometime around 2018, my forward dividend income will exceed my monthly expenses . I find dividends to be a more stable and de...
There are many risks to investing . One of the major risks that could ruin a portfolio’s chances of generating adequate dividends are p...
My goal is generate a sufficient stream of dividends that exceeds my expenses. In order to achieve that, I try to identify companies that h...
As many of you know, I have several brokerage accounts. In an earlier article I discussed that I do this, in order to protect my capital ...
In my investing, I try to put money to work every single month. I am extremely lucky that I have never had any material amount of debt, that...
I have been overdosing on everything about Warren Buffett in the past two-three years. This has spilled over to learning more about Warren’...