The conventional press has maligned annuities for years due to high fees and surrender charges, as well they should… when they exist. Confused yet? You should be. We have all heard the saying about throwing out the baby with the bath water and the same can be said about annuities. If we group all annuities into the “high fee” category we will be throwing out the baby.
Before we continue our thoughts we must express what we feel is obvious. All financial products have a cost of doing business whether it is a reduction of dividends returned, a fee or a charge. Financial professionals, investment and insurance companies are all compensated for their efforts in assisting you. So as we proceed we are not seeking to find the “free lunch” financial product – we are trying to make sure that you understand what you are paying so that you can make the determination as an informed consumer.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Dick and Eric discuss annuity fees and some of the hazards and misconceptions of with differing types of annuities.
Annuities come in many “Flavors”
A trip to your local financial professional to select an annuity can seem a lot like a visit to Baskin Robbins… you may end up wishing there were only 31 flavors.
Let start on the most basic level (the chocolate, vanilla & strawberry if you will), here we have variable, immediate and fixed annuities. Variable annuities have fees… lots of them typically. Fixed and immediate annuities typically do not have any fees or charges.
Variable Annuities
Variable annuities all have at the very least mortality and/or expense charges (M&E). This fee pays for the insurance **guarantee, commissions, selling, and administrative expenses of the contract.
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Your next questions should be, “What do I get for paying this fee?” You usually get an added death benefit that basically **guarantees that your account will hold a certain value if you die before the annuity payments begin. This typically means that your beneficiary will at least receive the total amount invested even if the account has lost money.
The other expenses in the M&E are just truly that – expenses.
In addition to M&E expenses variable annuities# (VA) also have management fees on subaccounts. The subaccounts are the mutual fund^ choices available within a VA. The management fees are the same as an investment manager’s fees within a mutual fund^. These fees will vary depending on the subaccount options within the annuity. Typically, they will be less than those charged by a managed mutual fund^ within the same investment category — though not always.
The fees associated with a VA’s riders and options can increase the cost of the VA significantly, but these are optional. However, I would hazard to say that most of today’s variable annuities# are sold because of the riders and **guarantees associated with them.
Why would anyone consider a VA with the amount of fees attached, two primary reasons; tax deferral and unlimited market upside potential.
Immediate and Fixed Annuities– the NO Fee Option
For the purpose of our fee discussion when we look at these annuities in their basics forms there are no fees are charges associated with these products. How do the agents and insurance company make money then you ask… similarly to the same way banks make money when you obtain a certificate of deposit. The expenses and cost are figured into the price of doing business by limiting or “managing” what they will return to you in the form of interest or dividends.
What about Equity Index or Fixed Index Annuities
Let me state this emphatically. A fixed index annuity is still a fixed annuity! So there are still no fees. All the index does is offer a choice to tie interest crediting to a gain in an index rather than a fixed number stated by the annuity provider.
Ready for the Chocolate Sprinkles – of Fixed Annuities
Due to the popularity of the income riders on variable annuities#, fixed annuities have begun to add their own riders – typically for a fee. Some of these annuities are referred to as “Hybrid Annuities” because the riders let you construct an annuity that can combine pieces from the fixed, immediate and variable worlds.
The Ever Popular Hybrid Annuity – Fees can be Tricky
Hybrid annuities typically charge fees for income riders. The income riders typically have fees of less than one percent. However, you need to be sure you know which account the fee is based from. Hybrids with income riders have an account or ledger that tracks the value of the income rider account growth – this account typically grows at a higher percentage than the cash accumulation account.
A key for understanding hybrid account fees is to determine which accumulation total the fee is based upon. Some companies use the number to determine the amount of fee, even though you cannot use this account for a lump sum withdrawal. Other companies use the actual cash accumulation amount to determine the fee. However, the fee is always deducted from the case accumulation account and never from the account.
Why would you pay a hybrid rider fee? Much like the variable income rider, the hybrid rider fee allow for predictability of accumulation for an account geared toward retirement income. The main difference is that the insurance company is assuming the investment risk with a hybrid annuity.
Conclusion
The fees and expenses imposed by some annuities can be costly to own. You have to understand what you are getting for those dollars you are giving up. Annuities of all varieties are basically tools to give you insurance on you income. They are vehicles that are designed to provide a . When utilized correctly they can provide a level of comfort and security for anyone wanting a **guaranteed lifetime income.
Annuities are multifaceted devices that can be key pieces of a savings or retirement plan. Do not let the popular media discourage you from choosing the best decision for your future! Understanding what each annuity fee does empowers you to the best decision for you.
Annuity Guys® Video Transcript:
Dick: We want to clear up some misconceptions maybe about annuities and fees, because you see that in the press a lot don’t you, Eric?
Eric: Oh, the conventional wisdom, everything you read, headlines, “Oh, annuities fees, don’t use them. They’re so bad, nasty, nasty, nasty.”
Dick: Now there is some truth to high fees in annuities. We don’t want to say that there isn’t any aspect of that that needs to be brought out.
Eric: Well, the analogy is throwing the baby out with the bathwater.
Dick: Yeah, we don’t want to do that.
Eric: If you’re going to cast all annuities as being bad, then you’re going to lose some good opportunities, because not all annuities if your fee driven, are bad.
Dick: Well, even the annuities that have the higher fees, in the right situation, if they’re presented properly, they may fit certain situations.
Eric: Exactly, usually you’re exchanging a fee for some kind of service or some kind of piece that you’re given.
Dick: Right, so you’re either going to pay a higher fee or perhaps you may earn a little less.
Eric: Let’s deal with the first flavor of what the highest, the typical highest fee annuity, which is the one that is most castigated about and written about, which is the variable annuity#. Variable annuities typically have higher fees.
Dick: Much higher fees.
Eric: And the reason is…
Dick: They have more upside potential. That’s one aspect of a variable annuity#, yet the fee structure has to do with mortality, because they have a death benefit.
Eric: A lot of them have a death benefit. Then they also have mutual fund^ options, their investment options. So what you’re doing is taking out an annuity wrapper, so to speak and wrapping it around a mutual fund^ option.
Dick: And typically Eric, when we have a mutual fund^ just an average fee structure for a mutual fund^, is approximately what?
Eric: Oh, you’re getting at least a.50%.
Dick: A half is minimal, pretty much.
Eric: Now I’m not talking about the load expense that you’re going to pay up front, your ongoing expenses could be .50% and usually 1.50%, so those fees exist in either world.
Dick: And I believe according to some data on Morning Star that they kind of look at the average and the average mutual fund^, is somewhere around 1.15% now. It used to be 1.5% not very long ago, but it is right around 1.15%. So you take 1.15% and say on a variable annuity# your mortality expense, your mortality and your expense ratio, M&E charges, you’re looking at an average of somewhere around maybe 1.50% or so. You put that with 1.15%, now you’re pushing you’re pushing 3.0%.
Eric: And then you start adding on the riders and that’s where the variable annuities# get really expensive, but that’s the…
Dick: That’s the **guarantee part of a variable annuity#.
Eric: Exactly, those are usually what most people are sold on, when they buy a variable annuity#. You want that insurance on your investment.
Dick: Right. So if the investments are not performing very well, obviously those fees are going to eat in pretty quick to the principal. In addition if you’re taking money out, so the principal may be at a little more risk, but the income is not or the potential for your heirs with a death benefit, because of the rider on the variable annuity#.
Eric: Right, but that’s typically the one thing we see out there when people are looking at fees, they’re looking at that variable annuity# and so you can have variable annuities# as low as .25% and as high as over 5.0%, if you start adding on all those riders.
Dick: It really adds up fast.
Eric: So there’s your high fee option. If you’re fee adverse knowing that your principal’s at risk and some other things with the variable knowing how they work, you have to make the educated choice.
Dick: Right, right and then a lot of times all annuities as we started out saying, in the press you tend to see annuity, high fee, but there are a lot of annuities that have no fees.
Eric: Exactly and when you look at fixed annuities and immediate annuities there are no fees.
Dick: There is no fee. It’s kind of known that you’re not, maybe going to earn as much—when I say you’re not going to earn as much; you’re don’t have as much earning potential, as you would have maybe in a variable annuity#, where it can earn as high as the market goes. You may have a declared interest rate in a fixed annuity or you may have an index option, which indexes to a popular S&P or Dow Jones or something of that nature.
Eric: And those are your low fee/no fee options. People say, “How do you get paid? How do those places make money if there are no fees?” Well, it’s the same way a CD at a bank. The bank doesn’t say, “Oh, I’m going to charge you a fee. I have to pay the salary of the guy that sold it to you.” It’s all factored in as a part of the price of doing business. It’s all built-in to that expense. So what you’re earning on that annuity is truly all, basically earnings. There are no fees that are taken out of those products.
Dick: So I think that’s one thing that we just want to clarify, is that when you are buying an annuity that there are some annuities that really virtually have no fees. They protect your principal. They maybe don’t have as much upside potential. They’re purchased for other reasons than just the potential of a high return. They are purchased for safety, for a more secure retirement vehicle, and those are the ones that do not have fees.
Eric: Now when we talk about fixed annuities and we say there are no fees there is of course the mystical hybrid annuity, which is built off of a fixed annuity chassis, in the sense of your principal is not at risk. However, there are fees associated typically through the riders.
Dick: Yes, there are.
Eric: That is one of the things, when you look at a fixed annuity you can’t just throw the blanket over the fixed annuity and say none of them have fees.
Dick: There are some fees.
Eric: Because if you’re going for that hybrid option, which has basically, an income rider or a long-term care rider, if you’re adding a rider on, that’s where you are going to potentially see fees.
Dick: Right. I do think that we have to add the caveat that the fees typically are very low on the indexed annuity, under 1.0% as a rule, and sometimes some of those riders come with no fee involved. We do want to make that clear.
Eric: Exactly, so it’s understanding, if the rider that you’re buying gets you further to what you’re trying to accomplish with either your savings plan or your retirement cash flow plan, those are the times you’re willing to give up some of that upside or you’re willing to pay for that **guarantee. It’s insurance on your money. It’s insurance on your retirement plan.
Dick: Well, you know that you can potentially by buying a rider, by paying a fee, say it’s a .50% or .75% something of that nature, you know that you can **guarantee that your income potential could double in 10-years of what you would have today, just by buying that rider. That could be money very well spent.
Eric: Well, you’re putting a **guarantee of your future income in the bank. You’re banking on that retirement dollar being there, you’re buying an income stream. That’s what those riders are designed for. They’re designed for income, not for accumulation. If you’re designing them for accumulation, you’re being sold a bag goods, because that’s not what they’re for. They’re income riders, for your future income.
Dick: Exactly. Well Eric, I don’t know that if we’ve cleared up everything on fees, today.
Eric: Well, not necessarily everything. I guess the one thing we should in closing with the hybrid annuity. There is one caveat that you always have to be careful, when you’re working with your adviser you want to ask, “Is the fee based off of the cash account or the accumulation account?” Now we’re not going to explain that in this video, because it would take us another 30 minutes.
Dick: But there’s another part of that I want to give a little clarity to and that is that the fee never comes out of the income account, so even though we haven’t gotten into the detail of the income account and the cash accumulation account, we’ve done that in some other videos. That the fee always comes out of the cash account, so it reduces your cash value, but the income account has whatever the compounding amount is in there, say if it’s 8.0%, it’s not deducted. There is nothing deducted. So now we’ve really confused you.
Eric: I was going to say, “Now we’ve confused you.”
Dick: You have to watch our next video.
Eric: Perfect time to call your financial adviser or to give us a call.
Dick: Or give us a call.
Eric: Thanks very much for watching.
Dick: Thank you.
