The Six Variable Annuity Fees You Need To Know About


Frazzled Francine wanted a second opinion on the Variable Annuity she had been sold.


A few months back, a prospective financial planning client came into my office to get my help determining if she has built up enough wealth to retire comfortably.  Let’s call her Frazzled Francine (not her real name). Francine had several different accounts with a few different financial advisors.  She told me that one of her accounts was her favorite.  When I asked her why, Francine responded, “because it has no fees and a great guarantee!”

That sounds pretty good to me, no fees and a big guarantee on investment returns. In fact, from a quick view of the statement, I knew that this was too good to be true.  Francine owned a Variable Annuity with a Living Benefit, which did come with a long list of fees and expenses.  Right on the statement, she handed me there was clearly listed a $15,000 Guaranteed Income Benefit Charge. This fee is billed annually and is clearly stated on one statement per year. Many of the other fees are hidden or much harder to determine.  We still needed to determine if this annuity was still something she should keep as part of her financial plan, high fees, or not.

Keep reading, and I will walk you through the various fees and charges that are common on many Variable Annuity Contracts.  I am not naming the specific annuity company Frazzled Francine used because I do not mean this as a review of any specific retirement account or variable annuity company, but more as a guide to help you figure out what that annuity you may own is costing you per year.  Similarly, there are so many options when it comes to guaranteed income from annuities, that it would be impossible to review them all in a single post.

Frazzled Francine’s Annuity:

Francine purchased the variable annuity several years ago from a stockbroker (business card says Senior Financial Advisor) who works specifically for the insurance company offering the annuity. The current balance is around $1,000,000.   She stated that the policy came with a fixed guaranteed interest rate of 7% per year, and no fees.  In her late sixties and in good health, she is nervous about the stock market and scared of running out of money in retirement.

As I’m sure you have gathered, this was not an accurate assessment of the annuity. While it did come with a 7% withdrawal benefit- this does not work the same as a guaranteed 7% interest rate.  It simply means that she could withdraw 7% of the “income base” each year. If the policy ran out of money before her life ended, the insurance portion would kick in and continue the payments for the rest of her life.  I have no problem with this type of guarantee, but I’ve never met anyone who actually understood what their benefit actually meant for them.  We will go deeper on annuity lifetime income riders in a future post.

Beyond the cost of the guarantees, this annuity policy came with a host of other fees and charges. Here are the 6 major variable annuity fees you need to be aware of.

You may see some Variable Annuity fees on your statement, a variety of other fees may be harder to find.


Annuity Account Fee:

Many annuity policies come with what is called an account fee or policy fee.  This typically is relatively minimal.  Typically, they run between $35 and $150 per year. Often, this fee will be waived once when your policy is above a certain asset level.  For example, the account fee may be waived on annuities with account balances above $50,000.

Frazzled Francine’s policy showed an account fee of Zero Dollars.  If I had to guess, this is where she got the idea that the policy had no fees. Alternatively, she may have been told by someone that there is no account fee on this policy.

Mortality Expense:

Annuity Contracts generally include some type of mortality and expense (M&E) charge.  This is included to cover the cost of death benefits (Annuities typically offer a death benefit) and other income guarantees associated with an annuity policy.  The total M&E risk charge typically ranges from 0.4 to 1.75 percent per year.

In this case, Francine owned an annuity with a 1.5% per year M&E charges.

Some annuities provide value, others with ridiculous fees are more like flushing money down the toilet.


Underlying Investment Fees:

As we mentioned above, Francine purchased this annuity to get the high guaranteed interest rate; she was sold.  Still, the underlying assets were invested into the various sub-account available on the annuity.  Depending on your policy and which funds you choose to invest with, these underlying investment fees can range anywhere from 0.25% per year up to 3% per year.

After some digging into the 120-page prospectus about her annuity, I saw that the fund line-up offered for Francine’s annuity had internal fees ranging between 0.6% and 1.85%.  Her average was about 1.4% per year.

So far, we have Frazzle Francine paying an M&E and fund expenses on her annuity totaling about 2.9 percent. However, we aren’t done yet.

Related: Can You Reach Financial Freedom Without Investing in the Stock Market?

Guaranteed Income Rider Fees:

Francine purchased this annuity primarily for the Lifetime Minimum Income Rider.  (These types of benefits are usually add ons to a variable annuity policy. You may also hear them called riders).  Like many people facing retirement, Frazzle Francine was nervous about running out of money in retirement.  I think having some guaranteed income is a great part of a retirement plan. That being said, not all annuities are created equally.  In this case, Francine purchased an additional guarantee on her annuity that cost 1.5 percent per year.

For those of you reading this that love the stock market, paying this extra fee for some type of guarantee will likely seem like a huge waste of money.  In this case, she was paying about $15,000 per year for what in her mind was portfolio insurance.  Without a guarantee, this money would likely have been sitting in a bank CD or something similar, earning far less than it had while in the annuity.  The account balance had nearly doubled during the time she owned the annuity policy. I take no credit for this, I did not put her in this annuity or manage the investments.   At this point, I am simply offering a second opinion as a Fiduciary Financial Planner.

Recap so far: M&E fees + Fund Fees + Rider Fees= Total Cost of About 4.4% per year.  Put in plain English, Frazzled Francine was paying about $44,000 in fees on her one million dollars in this variable annuity.

Other Riders Or Annuity Expenses:

There is a long list of other items or benefits that can be added to an annuity policy.  While Frazzled Francine didn’t own any of them, but you should still be aware of what they are so you know to look at the underlying fees in case you own an annuity with them, or are considering purchasing an annuity with them.  These additional benefits could be a Long Term Care Rider, Joint Life or Spousal Income Rider, Death Benefit Rider, or even minimum accumulation benefit.  The names will vary, but I think these are the main areas that are likely to be covered.

Some Variable Annuities will come with optional Long Term Care Riders


Variable Annuity Surrender Fees:

If you buy a traditional Variable annuity (that pays a stockbroker a nice commission often 7-15% upfront), you will be subject to a surrender charge.  This expense will only matter if you take money out of the policy during a specific time frame.

You need to be aware of this potential charge; it shouldn’t be an issue for most retirees who own annuities.  The free withdrawal option generally allows you to withdraw up to 10% per year without incurring a surrender charge. If you are using the annuity for retirement income, a withdrawal rate anywhere near 10% is a recipe for running out of money well before you run out of life.

In this case, Frazzled Francine owned an annuity with a nine-year surrender charge.  Fees started at 9.5% and went down each year she owned the policy.  Surrender charges are mostly an issue when you realize you have been sold a crappy annuity and want to get out, or when you need to access a large amount of money in an emergency.

Should Annuities Have a Bad Rap?

By no means are annuities appropriate for everyone reading this post.  In my experience over the past 16 years working as a fiduciary financial planner is that most gripes over annuities come from how they were sold, rather than the value of the underlying policies.

My parents owned an annuity before I was born. I’ve heard from my mother a million times their stockbroker churned their account in the eighties from the “best annuity” to one that wasn’t as good so he could get a huge commission. This money was put into a Non-Qualified annuity, which meant the money needed to stay in the annuity world.   If you have an annuity within an IRA or Roth IRA, once you are out of the surrender charge period, you can just transfer your account to any investment provider you like.

If you are working with a fee-only financial advisor (who doesn’t earn commissions), they should be able to help you find an appropriate variable annuity without a surrender charge.  At the very least a much shorter surrender period. I have seen some fee-only annuities with a one-year surrender charge.  Generally speaking, any investment you make, you should be comfortable leaving it where it is for at least one year.

Frazzled Fran Loves her Variable Annuity, others may hate them.


Annuity Owners Often Love Annuities:

If you are reading this post, you likely have an opinion about annuities.   Some people love them; others hate them.  76% of people who owned an annuity with a Guaranteed Income rider said they would recommend that people buy similar annuities according to a survey from Cannex.

While many in the financial media appear to be anti-annuity, you may want to take some of their advice with a grain of salt.  Everyone has their conflicts and biases, and anytime someone says “always” or “never” they are throwing out generic advice that has nothing to do with your situation.

What Did I Recommend For Frazzled Francine?

Ultimately, we decided as part of her comprehensive financial plan that Francine would keep most of the variable annuity.  Her great grandmother lived to 99 years old, and one of Frazzle Francine’s biggest concerns is her money lasting the rest of what we hope is a very long life.

Between the annuity guaranteed payments, Francine would have enough money to cover the essentials for the rest of her life.  It provided a nice floor on the amount of income she could take for the rest of her life. As well as she stated, “I will sleep better at night knowing that at least some of my money has a fixed rate on it.”  Keep in mind the guarantees are based on the ability of the insurance company to pay them.  So from that perspective, choose your annuity company wisely.

She also had a good amount of other assets to use for her more fun expenses. Think things like travel, hobbies, and time with her grandchildren.  While she was not happy to learn about the fees, and how the income rider actually worked, she still found benefits in the policy when she actually understood it.  We did move her other investment from high-cost mutual funds (some had internal fees as high as 2.9%) to a well-diversified portfolio of low-cost index funds (average fees are below 0.10% per year).

Would I put Frazzled Francine’s other money into this same annuity? No, I wouldn’t.  However, this policy does meet some of her financial planning needs.  We are currently ten years into a great bull market, Francine will see another recession (likely several) in her lifetime, and hopefully, the guaranteed income from this annuity will help her feel a little less frazzled.  I will say that my clients, who have guarantees on some of their investments, had an easier time coping with the financial stress of the great recession.  Staying invested over the past decade has paid off handsomely for them and others like them.

This annuity was expensive (many of them are) and we will continue to monitor her options going forward.  In this case, we left the funds where they stood (with a new investment allocation), but for many of you, the choice to move the money will likely make more sense.

Annuities are simply a tool to help you reach your various financial goals.  Right now, you may not need this tool, but it is good to know where to find it, on the occasion that you do need it. Just like you can’t fix everything with a hammer, you can’t fix all retirement problems with an annuity. So make sure you talk with someone who has more than one tool to try and fix your retirement issues with.

If you own an annuity, consider getting a second opinion from fee-only Certified Financial Planner™.  They can help you figure out the fees you are paying on that variable annuity. More importantly, they can help you decide if these fees provide enough value for you to keep the annuity.

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