Paying the Price: Variable Annuities Often Bogged Down by Excessive Fees

Although many annuities can nickel-and-dime investors with layered fees, variable annuity fees tend to be an especially pricey bunch. Unfortunately, many investors don’t fully understand all the fees associated with variable annuities.

Don’t go in blind. Consider all the fees first—compare variable annuity costs with other investment costs before making your choice. Variable annuities might not deliver everything they promise because they are generally weighed down by complex fee structures that dig into your wallet.

Variable annuity fees are often so complex, it can take a salesperson several attempts to explain. In the following, we hope to help you identify and understand some of the most common fees associated with them. Also, you should consider the cost of any added features, or “riders”, that you might be offered. These riders intend to make the annuity even more beneficial, but often extract even more fees that may eat away at potential returns.

Basic Fees

Here are some of the most common fees associated with variable annuities:

  • Mortality & expense fees. Also called M&E fees, these are the fees the annuity charges for taking on risks associated with this form of insurance (potentially paying out more than you put in).
  • Administrative fees. These fees cover the costs needed to service the annuity, including the office staff, paperwork, cost of delivering payouts and other expenses.
  • Sub-account expense ratios. Variable annuities usually give you the option to invest in a selection of assets such as mutual funds. Like other managed funds, these mutual funds typically charge an additional fee to cover their own trading and transaction costs.
  • Surrender charges. Not all annuities charge sales fees directly. Many annuities come with Contingent Deferred Sales Charges (CDSC)—often called a surrender fee. These fees are charged if you withdraw more than the amount allotted in your contract in a given year. These charges help prevent investors from cashing out of their annuities before the custodian has had a chance to recoup the costs of sales commissions.

Riders

Along with the typical annuity charges, many insurers offer investors the option to purchase additional features, called riders, with their variable annuities (and other annuity types). Riders can be very popular due to their advertised benefits, but usually come with additional fees. These added variable annuity fees can eat into annuity returns, so be careful to weigh the potential benefits riders provide relative to their costs.

Annuity riders generally fall into one of two categories:

As you might expect, these correspond to whether the protection goes into effect during your lifetime or after you pass away.

Another important note: Individual annuity providers may call these riders different names or define them differently. Above all, remember that you may only truly know what’s offered by thoroughly reading an annuity’s contract and any associated riders’ contracts. These contracts can be long and full of legalese, but don’t let that deter you. Not reading carefully means you could be stuck with less than beneficial results for a long time. Annuities can be difficult to get out of without a financial penalty. Riders add another layer to the standard variable annuity fees and the fees of most other types of annuities.

Some common variable annuity riders for living benefits include:

  • Guaranteed lifetime withdrawal benefits (GLWB). This rider can provide you a guaranteed income stream lasting your entire life, even if your principal would otherwise have been depleted. Depending on the contract terms, you could withdraw a certain percentage of the total account as income each year without annuitizing the contract and beginning to receive payments.
  • Guaranteed minimum withdrawal benefits (GMWB). This rider can offer a guaranteed minimum income stream, but only over a pre-determined period—typically over the contract’s term or until the total amount paid equals the principal value. However, it is important to remember that the purchasing power of this money may be less than when it was deposited due to inflation.
  • Guaranteed minimum income benefit (GMIB). Unlike the GLWB and GMWB above, this rider must be annuitized—you can’t take income without annuitization. A GMIB creates a floor rate for your variable annuity, guaranteeing a certain level of return. But as you might expect, this type of rider can be particularly costly as the insurer is assuming greater risk for guaranteeing that growth. This rider may also come with an associated ceiling rate that could cap your gains above a certain level.

Common riders for death benefits include:

  • Basic death benefits. With this rider, your heirs can recover the value remaining in your annuity at your death before it is annuitized. But if the policy has been annuitized, there is no death benefit.
  • Enhanced death benefits. These come in a variety of forms, but two common ones are Highest Balance or Minimum Benefit. With a Highest Balance benefit, the payment to heirs is based on the highest value the account reached. With a Minimum Benefit, the value is calculated similarly to a Minimum Income benefit, as a fixed percentage, compounding return on deposits. But remember: These benefits usually only go into effect if they will provide more than the annuity’s current value. So, if the annuity’s value is greater than the death benefit when the purchaser passes away, these benefits will not be applicable.

For most death benefits, there comes an age (usually around age 85) at which the annuity contract requires you to annuitize.  Remember, after annuitization, you lose any death benefits.

Weighing the Effect of Fees

In addition to basic fees, the fees from riders can quickly pile up if you choose to add them to your plan, and they can weigh even further on your returns.

Because of all the fees, the performance of a variable annuity’s underlying investments may lag behind similar direct investments, even over a relatively short time period of around 10 years. Consider the fees of an average variable annuity with one common rider:

  • Annual annuity fees generally are 1.21% on average.1
  • Many variable annuities are invested in mutual funds, which will also charge an annual fee averaging 0.63% as of 2017.2
  • Guaranteed Lifetime Withdrawal Benefit rider fees range between 0.35% and 1.60% annually.3

In the above example, the hypothetical variable annuity fees with one rider could amount to 3.44% annually! Imagine the potential effect on a $100,000 initial investment assuming a 0% rate of return and fees and expenses based on a one-year period. An investor who placed his or her money in this variable annuity and its riders would owe fees of around $3,440 in the first year, compared with just $630 for the same $100,000 invested in a mutual fund (using the 0.63% average annual mutual fund fee mentioned above). That’s a difference of about $2,810.

To provide some context, Let’s say you decided not to buy the variable annuity and instead invested that extra savings every year. If you continued to invest the same savings every year—even with a conservative average return of 3%—you might end up saving tens of thousands of dollars after a decade. That is money you would forgo with the variable annuity, because that cash would have instead been paid in fees. For many retirees, those savings could represent a full year of living expenses, and it certainly isn’t an amount that anyone would want disappearing into the pockets of an annuity custodian.

The chance of forgoing such potential growth in just 10 years shows how significant the cost of variable annuity fees could be. That is why we believe you need to carefully consider what you are getting into with a variable annuity, and read any materials associated with the investment with a detailed eye on the small print.

Discuss Variable Annuity Fees

If you have questions about variable annuity fees, or would like a second opinion on an annuity, request an appointment with us now. Fisher Investments has Annuity Counselors to help you understand annuities and their potential short-comings.


1Insured Retirement Institute, 2016 IRI Fact Book (Washington, DC: IRI, 2016), 114.

2Investment Company Institute, 2017 ICI Fact Book, https://www.ici.org/pdf/2017_factbook.pdf, 89.

3Insured Retirement Institute, 2016 IRI Fact Book (Washington, DC: IRI, 2016), 102.