A variable annuity is an insurance contract with investments inside it. Your money goes into funds, similar to mutual funds, and the contract adds insurance features such as a death benefit or a guaranteed income.
Each of those pieces has a price. The trouble is that they are listed separately, in different parts of a long document, so almost nobody adds them up.
The SEC’s guide to variable annuities walks through each one. Here they are in order.
Layer 1: the contract fee
Often called the mortality and expense risk charge. It pays the insurer for the insurance guarantees, and part of it may go toward the pay of the person who sold the contract. The SEC’s example figure is 1.25% of your account value per year.
Layer 2: administration
Record keeping and paperwork. Sometimes a flat $25 or $50 a year. Sometimes a percentage of the account, such as 0.15%.
Layers 1 and 2 together, using the SEC’s example numbers, come to 1.40% a year. You have not paid for a single investment yet.
Layer 3: the funds inside
Each investment option in the contract has its own yearly expenses, just as a mutual fund does. These are taken out of the fund’s returns.
Layer 4: riders
Optional features: a guaranteed minimum income, an enhanced death benefit, a guaranteed withdrawal amount. Each carries its own yearly charge.
Layer 5: the exit
A surrender charge if you take out more than a set amount in the early years. It usually steps down each year until it disappears.
Add yours up
Take the SEC’s 1.40% for the first two layers. Suppose the funds inside cost 0.80% and one income rider costs 1.00%. Those last two are my example numbers. Yours will be in your contract.
That is 3.20% a year.
Now think about what that means. If the investments inside earn 8% before costs, you keep 4.8%. More than a third of the return goes to the layers, every year, whether the market is up or down.
No single fee looks large. That is how the total gets large.
Where to find each number
In the prospectus, look for a section called “Fee Table” or “Fees and Expenses.” It lists the contract charges, the range of fund expenses, and each rider’s cost. Your annual statement shows which funds and riders you actually hold.
If that sounds like a chore, call the insurance company and ask one question: “What is my total annual cost as a percentage, including the contract charges, my funds and my riders?” They can tell you.
Two things worth knowing
Inside an IRA, the tax benefit is doubled up for nothing. The SEC says it directly: if you hold a variable annuity inside an IRA or a 401(k), you get no additional tax advantage from the annuity. You are paying for a feature you already had.
Bonus credits are not free money. Some contracts add a bonus to what you put in. The SEC warns that these contracts may carry higher fees and expenses, and that the extra cost might outweigh the bonus.
What to do with the total
First, decide what you are getting for it. If you have a rider you truly intend to use, such as guaranteed lifetime income, price what that guarantee is worth to you.
If you are paying for guarantees you never plan to use, you have an expensive investment account. Whether to keep it or leave depends on the surrender charge and the taxes. Do not move in a hurry. That is The No-Memory Test: ignore what you already paid, and ask whether you would buy this today.
Related questions: should I cash out my annuity, is a fixed index annuity a good idea, mutual fund loads and 12b-1 fees and should I roll my 401(k) into an annuity.
One question for this week: can you name every rider on your contract and say what each one costs? If not, that is the phone call to make.
As always, if you want to talk any of this through, the door is open. Genti