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    Understanding Annuity Fee Structures

    For the right people, and in the right situation, annuities can be the best solution for addressing long term needs; however, they tend to receive their share of bad press for being too “complicated” or too “expensive”. For people who have not taken some time to understand how annuities work and how their fees are structured, these criticisms may very well hold true. The reality is that annuities are fairly straightforward in their actual applications – to save money or to generate guaranteed income. But, as with other types of investments, they are laden with fees and expenses that, if not understood, could make the product seem more complicated and expensive than it really is. The key is to be able to weigh the expenses against the long term benefits received to really determine if it makes sense as an investment. The outcome will vary depending on your specific situation.

    It’s about Cost vs. Value

    Unlike standard savings vehicles such as deposit accounts or bank CDs, annuities include many features that can enhance the accumulation results for the saver. Features such as tax deferral, minimum rate guarantees, withdrawal flexibility, death benefit guarantees, minimum income guarantees all serve to provide savers with the ultimate in accumulation and financial security opportunities. But, a reasonable person would agree that these extra features would likely come at some cost in any type of savings vehicles. The real question is how important these extra features are to you and whether they are worth the added cost. The answer will differ from one person to the next. It would be important, therefore, to take some time to understand annuity fee structures so you can be in a position to weigh the benefits.

    Annuity Fee Structure Components

    Mortality and Expense Charge:

    At their core, annuities are insurance contracts issued by life insurance companies. The insurance element is the death benefit feature which protects your principal investment, at a minimum, and your total account value, at a maximum, for the benefit of your survivors. Life insurers need to cover the cost of this insurance risk, so they apply a mortality charge which is a fixed percentage of the account value. The charge also covers other costs associated with marketing and administration. On average the M & E charge ranges between .5% and 1.5%.
    Savings Tip: M & E charges for annuity products are published in the prospectus (in the case of variable annuities) or the sample contract. Shop and compare to find the lower M & E charge and you can add hundreds, if not thousands to your accumulation account over the long term. Be on the lookout for contracts with low M & E fees that try to offset them with higher surrender fees.

    Surrender Fees:

    Surrender fees present the biggest challenge for savers as they do vary greatly and they can be somewhat convoluted in their structure. They also represent the single biggest expense if the unexpected need for a sizable withdrawal occurs. So, it is vitally important to understand how it works. The good news is that annuities do allow for annual withdrawals. But if the withdrawal exceeds 10% of the account value, and it occurs within the surrender period, the excess will trigger a fee. Typically, the surrender fee starts out high, somewhere in the range of 7% to 12%, and then it declines by a percentage point each year. When the fee percentage reaches zero, the surrender period expires and withdrawals can then be made without fees. So, if you do the math, the surrender period can last as many as 12 years. For many annuity owners, the surrender fee is not a concern because of their commitment to the long term for their annuity savings. At the very least, annuities do offer flexibility and liquidity which, if the need for funds arises, can be a good source of emergency funds.
    Savings Tip: Again, surrender fee structure is published, so they can be compared to determine which contract has the most flexible or liberal provisions. Be aware of the contracts that have very short surrender periods or low fees, because the insurer may find ways to offset them by charging higher fees elsewhere or with lower minimum rate guarantees.

    Management Fees:

    Variable annuities include an additional fee to cover the cost of managing the investment accounts. These are similar to the fees charged by mutual funds, ranging between .4% and 1% depending on the type of investment account. More actively managed accounts such as a small growth stock account, may have more trading activity so the fee would be higher than a high quality bond account which requires minimal activity. It is important to note that, when looking at an investment account’s net asset value performance, the return percentage does not usually reflect the cost of the management fee.
    Savings Tip: Shop and compare. There really is no correlation between the size of management fees and investment performance, so lower fees are better in the long run.

    Sales Charges:

    Most annuities do include some sort of sales charge. The more commonly applied method is the contingent deferred sales charge in which the sales cost (including commissions paid to the annuity salesperson) is recovered through the surrender fee at the time an excess withdrawal is made. So, with this method, nothing is deducted from your deposit or account value up front. The other method is through a front-end sales load, in which a percentage is deducted from the deposit or the account value.
    Savings Tip: More annuity providers are moving away from front-end sales loads. Most annuity contracts are structured with a contingent deferred sales charge and are referred to as no-load funds. Variable contracts are more likely to include a front-end sales charge; however, no-load contracts are becoming more widely available. Shop, compare, and save.

    Other fees and expenses include state premium taxes (not in all states) which amount to an annual 2% charge; an annual policy fee which is usually a flat dollar amount like $30; transaction fees which may apply in a variable contract if excess transfers between accounts occur; and fees for any optional features.


    OK, it does seem like a lot of nickel and diming, and in some contracts, the fees can really add up. As with any type of purchase, the cost should be weighed against the expected value to be received. Unquestionably, the costs in some annuity contracts could very well counter the extra value that the annuity is expected to deliver. Using these simple savings tips, you can keep your costs to a minimum which will ensure you receive the maximum value from your annuity.