What Are Variable Annuities?

Thinking about purchasing variable annuities? Gear up—there is plenty to learn. These are notoriously complex products, and hearing a second opinion before signing on the dotted line is prudent to avoiding post-purchase regret. Peel back the “guarantees,” fancy features and promises of safe, stable returns, and you may not like what you see.

Insurance, Only Worse

Depending on the contract, the premium may provide you with a stream of income for your life or a death benefit to your heirs upon your passing.

Alas, nothing comes free, and these policies carry large costs. First, “mortality and expense” fees—the basic cost of insurance for variable annuities—can average around 1.18% or more. Operating and administrative fees can add another 0.19%i. Additionally, like other insurance policies, companies offer a host of fancy-sounding add-ons called riders. Most riders carry additional fees, which can add another 0.2-1.8%, depending on the company and the available options. These fees can add up quickly to provide a significant headwind against long-term growth potential of the variable annuities.

An Investment, Only Worse

Your premium is invested in mutual fund-like vehicles you pick from a menu (where the choices are generally slim). Once again, fees in variable annuities take a large toll. These funds can average 0.94% per yearii. Oh, and the funds fluctuate with markets—returns aren’t assured.

Tally everything up, and it isn’t uncommon to find total fees for variable annuities (insurance costs, riders and fund fees) exceeding 3%. Sometimes more! These are crippling sums. Historically, stocks have returned nearly 10% a year on average.iii At that rate, $100,000 invested for 30 years would grow to just over $1.7 million. Reduce returns to 7%, and that same $100,000 would grow to $761,000. If you include bonds, the picture is even starker. Bonds’ historical gains range between 4 and 6%, depending on type—3% in annuity fees could more than halve those returns.iv

The funny thing is, it seems most people who buy variable annuities eventually catch on. If that’s you and you recently purchased an annuity, you could face another cost: huge surrender charges, often as high as 7% and lasting for nearly a decade to keep you in.v We ask you: If these products are so great at assuring financial freedom and funding your retirement, why must they scare you to stay in it with huge charges? If variable annuities are all they are cracked up to be, wouldn’t folks choose to do so on their own?

iSource: Insured Retirement Institute, 2011 IRI Fact Book (Washington, DC: IRI, 2011) 36-38, 56
iiSource: Insured Retirement Institute, 2011 IRI Fact Book (Washington, DC: IRI, 2011) 36-38, 56
iiiSource: FactSet, Global Financial Data, as of 02/11/2016. S&P 500, from January 1926 – December 2015.
ivIbid. Annualized total return of US AAA-Corporate Bonds (20+ year maturity), US 10-Year Treasury and US Municipal Bonds (10+ year maturity), 1926 – 2015.
vSource: IRI Fact Book 2016, Insured Retirement Institute, Page 61.

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