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Insurance companies offer annuities to individuals looking to augment their income during their golden years. Those who enter into an annuity contract pay a certain amount of cash either in a lump sum or in installments, then later receive payments (either in a lump sum or regular payouts).
Of course, this isn’t money for nothing. Annuities often come with a range of fees, commissions, and hidden charges. It’s wise to consider these costs before engaging in any annuity contract.
Key Takeaways
- Annuity fees and commissions can significantly impact the overall cost and returns of an annuity investment.
- Different types of annuities have varying fee structures, affecting their suitability for different investors.
- Understanding the purpose and structure of fees and commissions helps in evaluating the true cost of annuities.
- Additional features and riders can increase annuity costs, requiring careful consideration.
- A cost-benefit analysis is essential to determine if an annuity aligns with personal financial goals.
What Are Annuity Fees and Commissions?
Two types of costs come with annuities: fees and commissions. Fees are charged by the insurance company to cover certain costs, such as insurance risk, administering the account, for the expenses of the investments. Fees also cover additional features, such as a guaranteed minimum income benefit or long-term care insurance.
Along with these fees, there are also commissions associated with an annuity contract. These are payments that go to the agent who helped set up your plan. But while you, as the annuitant, have to pay fees, the commission is usually covered by the insurer and built into the contract.
Warning
Warning: Be wary of agents who may direct you to more expensive annuity products to boost their own bottom line.
There’s another charge that you should be aware of as well when it comes to an annuity: early withdrawals from annuities are subject to a 10% IRS penalty plus income tax (unless an exception applies).
Types of Annuity Fees
Administrative Fees
Similar to other financial products, such as a 401(k) or IRA, the issuer may charge you for the recordkeeping and other administrative expenses of your annuity contract. This may be a flat annual fee, or a percentage of your account value, typically about 0.3%. Comparatively, 401(k) fees can range between 0.5% and 1% or even higher, depending on plan size and investment options.
Mortality and Expense Risk Charges
As an insurance product, annuities come with risk. Typically found in variable annuities, the insurer will charge you about 1.25% of the account value annually for the risk it assumes under the contract. According to the SEC, the profit from this charge is sometimes used to pay a commission to the person who sold you the annuity.
Surrender Charges
Say you bought into a variable annuity but need money sooner than you anticipated. During the surrender period, which is usually six to eight years after buying the annuity, you decide to sell or withdraw funds from the contract. You’ll now be subject to a surrender charge by the insurer.
These vary from contract to contract but are typically steep, starting as high as 7% in the first year, then dropping 1 percentage point each year before disappearing entirely. The value and potential returns of your annuity will be reduced if you opt to withdraw early.
Investment Expense Ratios and Rate Spreads
These costs are only applicable to certain kinds of annuities, particularly variable and fixed index annuities. The investment expense ratio is a fee for managing the annuity’s investments, and could range from 0.6% to 3% each year.
Rate spreads are applied to fixed index annuities, which typically offer a guaranteed minimum rate of return. The spread covers the risk insurers take on by providing that benefit. The insurance company will set a percentage for the interest rate spread each new contract year.
Understanding Annuity Commissions
For annuities, you are usually not directly responsible for paying the commission, which is the payment due to the individual who set up your contract. The commission is typically built into the price of the contract, and could range based on the total value and complexity of the annuity — the higher the complexity, the higher the commission. Again, beware of agents that steer you toward more complex annuity products if they’re beyond your needs.
For example, the commission for a single premium immediate annuity or multi-year guaranteed annuity may be 1% to 3%, a deferred income annuity may be 2% to 4%, while a fixed index annuity may fetch a commission between 6% to 8%.
Factors Influencing Annuity Costs
Annuity Type
All annuities are subject to administrative fees and a commission, the latter of which you are usually not directly responsible for. As an annuity product becomes more complex, you’ll have to pay more fees to the insurer.
On the simpler side, for example, an immediate annuity is purchased with a lump sum payment and is not subject to any additional fees unless you add a rider. A fixed annuity generally exposes buyers to the least risk while providing the most predictability by having a guaranteed, set interest rate that is locked in when you sign your contract. Along with administrative fees, these plans include surrender charges that you only pay if you withdraw early.
On the other hand, variable annuities and fixed index annuities are subject to market factors and hence carry more fees, including mortality and expense risk charges, investment expense ratios, and rate spreads.
Customization and Riders
If you’d like to add additional features to your annuity contract, this is possible through riders. For example, minimum withdrawal benefits allow a certain percentage of the principal to be withdrawn annually for the rest of your life, no matter how markets perform.
There are also death benefits that, say, allow a new annuitant to be named in case of your premature death. Yet another rider increases the amount of payments to adjust for inflation. Each of these additional features adds costs to your contract, therefore lowering your payments.
Evaluating Annuity Costs: Is It Worth It?
As each annuity contract comes with its own fees, you’ll have to determine whether the costs are worth the benefits. A financial planner can help you make that determination.
Investors and retirees like annuities because they provide another source of retirement income and are fairly predictable when they’re not tied to markets. But as these products become more complex and provide the potential for higher returns, the fees will become higher.
Consider your financial goals and appetite for risk when deciding between different annuities and their subsequent costs.
How Do Annuity Fees Compare to Fees for Other Investment Products?
Annuities often have high fees compared to investment products such as mutual funds and ETFs. With these fees, however, come benefits including guaranteed income and tax-deferred growth.
Can Annuity Fees Be Negotiated or Reduced?
Yes, it’s possible to negotiate annuity fees. The more money you’re investing into the insurance company, the more open they may be to negotiating. Speak with your financial advisor and/or annuity agent to explore your options.
How Do I Know if I’m Paying Too Much in Fees and Commissions?
For you to make this determination, you should calculate the potential return of your annuity contract and weigh that against how much you have to pay in, as well as any annual fees you will have to pay.
Besides Fees and Commissions, What Should I Consider When Choosing an Annuity Provider?
One of the most important considerations when choosing an annuity provider is its credit rating. The financial strength of each company is evaluated by credit rating agencies, including AM Best, Fitch, Kroll Bond Rating Agency, Moody’s, and S&P Global. These ratings will give you an idea of how secure an insurance company is against market forces.
The Bottom Line
Annuities can provide an additional source of retirement income, but the fees insurance companies charge vary based on the complexity of the product and the total value of the contract. The agent who sold you the annuity will earn a commission, so be on the lookout if they’re directing you to a more complex product than you need. Commissions are typically built into the contract, and you do not pay for them directly.
Before purchasing an annuity, evaluate the fees so you know how much you’ll be expected to pay. Consult a financial advisor if you need assistance.
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