| Annuity Basics | Contract Fees
Costs involved with owning a variable annuity The contract fees and expenses for your variable annuity contract can differ depending on the services and benefits provided. This information is contained within the prospectus, which should be read carefully prior to investing. Some fees are associated with administering the variable annuity contract. Other fees are used to provide insurance benefits, and still others to offset the costs of managing the investment portfolios. The fees can vary depending on the contract you select and the way you allocate your assets within the contract. Most experts agree that cost shouldn't be the only reason for selecting or rejecting a contract or an individual investment portfolio. It’s also important to look at the benefits and services the annuity contract provides, as well as the performance of their investment portfolios. Annual and Asset-Based Fees Annual fees are fixed expenses that are deducted from your contract account value and average about $30 a year. Asset-based fees are a percentage of the total value of your annuity (other than money allocated to the fixed account), deducted on a daily basis. Many contracts waive the annual fees when the value of your variable annuity account reaches a certain value, generally between $25,000 and $50,000. But the larger your account grows the more total dollars you’ll pay in asset-based fees. Mortality and Expense Fee (M&E)
The cost of these insurance features typically ranges up to 1.5% of the total value of your variable annuity each year, with the 2000/2001 average at 1.158% according to VARDS. In most cases, the fee is subtracted proportionally from each of the investment portfolios into which you’ve put money. When comparing a number of contracts, you’ll find that sometimes the M&E fee is higher than average, while administrative and maintenance fees are lower, or vice versa. Experts suggest that what you look at is the entire fee package, rather than any single component, in evaluating a contract. More Benefits/More Cost In general, you pay for these enhancements in additional fees. The fees generally reflect the nature and extent of the risks and expenses the company is assuming in providing these extra services. Of course, you also have the opportunity to choose a lower-priced contract with fewer extras. On the other hand, if some or all of these options are important to you or make you more comfortable about committing your money to a variable annuity contract, it may make sense to select a contract that provides them. Such enhanced benefits also have restrictions which may reduce or void the benefit. Stepped Up Death Benefits The insurer might guarantee payment of the premium amount, plus a fixed annual rate of interest. For example, if you put $100,000 into an annuity, your beneficiary would be entitled to at least that amount, plus interest compounded annually at the rate specified in the contract. Some insurers offer a death benefit feature that allows you to lock in your investment gains every year or every few years. For example, if your variable annuity contract increased from $100,000 to $142,500 by its fifth anniversary date, many contracts lock in that $142,500 as the new minimum death benefit guarantee. Even if your annuity dropped in value in the following year, your beneficiary would still be entitled to the $142,500. What do these contract fees pay for? Some of the fees pay for the insurance benefits that variable annuities contracts provide. Other fees pay for the operation and management of the individual investment portfolios. Management Fees According to the National Association for Variable Annuities (NAVA), management fees average about 0.77% annually, but the actual charge can vary quite dramatically, based on the size of the fund or the way the portfolio invests. For example, fees on index portfolios tend to be significantly lower than fees on international equity portfolios or those requiring extensive or ongoing research and oversight. In a fixed account within variable annuities contracts, the expenses are paid by the account’s interest margin. This margin is the difference between the percentage being earned on investments made by the company and the percentage being credited to your account as earnings. Surrender Fees Surrender fees serve several purposes. First, they make people think twice before taking their money out, and thereby interrupting the growth opportunity of their long-term retirement account. The fee also benefits the annuity company, as it has significant upfront expenses in issuing the contracts. These include sales and marketing expenses, insurance underwriting costs, and other such expenses. The insurance company counts on receiving asset-based fees or interest margins over a period of years and the surrender fees cover this loss of income that results when the annuity is ended earlier than projected. Are Variable Annuities Cost-Effective? Variable annuities can make sense for investors interested in:
Additionally, many investors appreciate the advice they may receive from the financial advisor who sold the annuity. Investors should be aware that the tax treatment of mutual funds varies from that of variable annuities. Mutual funds gains are subject to capital gains tax whereas gains in variable annuities are taxed as ordinary income upon withdrawal. Expense Ratios The average expense ratio, including management and contract fees, according to Morningstar is 2.14%. You can check the expense ratio figures on your own, and you can also ask for that information from the insurance company or your financial advisor. Even for portfolios offered by a single annuity contract, you’ll notice that the difference in expense ratios can be significant. Those variations are the result of differing management expenses. Although you probably won’t want to base your choice of your annuity investments on expense ratio alone, it should be one of the factors you consider, particularly when choosing among those with comparable performance records. |