Annuity Contract Fees: How to Protect Yourself

by Rob Phillips, CPA

The contract fees and expenses for your variable annuity contract can differ depending on the services and benefits provided. This information is contained within the prospectus, which should be read carefully prior to investing.

Some fees are associated with administering the variable annuity contract. Other fees are used to provide insurance benefits, and still others to offset the costs of managing the investment portfolios. The fees can vary depending on the contract you select and the way you allocate your assets within the contract.

Most experts agree that cost shouldn’t be the only reason for selecting or rejecting a contract or an individual investment portfolio. It’s also important to look at the benefits and services the annuity contract provides, as well as the performance of their investment portfolios.

Annual and Asset-Based Fees

Fees for variable annuity contracts are calculated on both an annual and asset basis.

Annual fees are fixed expenses that are deducted from your contract account value and average about $30 a year. Asset-based fees are a percentage of the total value of your annuity (other than money allocated to the fixed account), deducted on a daily basis.

Many contracts waive the annual fees when the value of your variable annuity account reaches a certain value, generally between $25,000 and $50,000. But the larger your account grows the more total dollars you’ll pay in asset-based fees.

Mortality and Expense Fee (M&E)

The asset-based M&E fee that is charged on all variable annuity contracts is designed to pay for four things:

  1. The guaranteed death benefit
  2. The option of a guaranteed lifetime payout
  3. The guarantee of minimum annuity purchase rates when you annuitize.
  4. The assurance that fixed insurance costs, including the M&E fee itself, will never exceed a specified maximum amount for the life of the contract

The cost of these insurance features typically ranges up to 1.5% of the total value of your variable annuity each year, with the 2000/2001 average at 1.158% according to VARDS. In most cases, the fee is subtracted proportionally from each of the investment portfolios into which you’ve put money.

When comparing a number of contracts, you’ll find that sometimes the M&E fee is higher than average, while administrative and maintenance fees are lower, or vice versa. Experts suggest that what you look at is the entire fee package, rather than any single component, in evaluating a contract.

More Benefits/More Cost

A number of variable annuity contracts offer features often described as enhanced benefits. One such benefit is a more generous death benefit guarantee, which locks in any portfolio gains (generally at contract anniversary or at specified intervals) for payment to your beneficiary should you die during the accumulation phase. Some companies now offer additional protection for your income payments during retirement.

These “guaranteed minimum income benefits” guarantee a minimum lifetime income stream when you convert the savings in your variable annuity into income payments. And companies are constantly offering innovative new features such as long-term care protection or other features to ensure that variable annuities provide comprehensive retirement income solutions.

In general, you pay for these enhancements in additional fees. The fees generally reflect the nature and extent of the risks and expenses the company is assuming in providing these extra services. Of course, you also have the opportunity to choose a lower-priced contract with fewer extras.

On the other hand, if some or all of these options are important to you or make you more comfortable about committing your money to a variable annuity contract, it may make sense to select a contract that provides them. Such enhanced benefits also have restrictions which may reduce or void the benefit.

Stepped Up Death Benefits

Initially, the death benefits guarantee provided that your beneficiary would receive the greater of your contract value or the amount of your premiums (minus any withdrawals) if you died during the accumulation phase of your variable annuity. Today, some insurers have added new features to make their annuities more attractive. This means the cost of the death benefit feature may be higher. You should decide whether the additional protection is worth the additional fee.

The insurer might guarantee payment of the premium amount, plus a fixed annual rate of interest. For example, if you put $100,000 into an annuity, your beneficiary would be entitled to at least that amount, plus interest compounded annually at the rate specified in the contract.

Some insurers offer a death benefit feature that allows you to lock in your investment gains every year or every few years. For example, if your variable annuity contract increased from $100,000 to $142,500 by its fifth anniversary date, many contracts lock in that $142,500 as the new minimum death benefit guarantee. Even if your annuity dropped in value in the following year, your beneficiary would still be entitled to the $142,500.

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