A variable annuity is a tax-deferred investment vehicle for providing retirement income. For individuals who have exhausted other avenues for tax-deferred growth such as a 401(k) or IRA, a variable annuity, at first glance, might seem like a sound, additional alternative.

There are a few obvious advantages. Aside from the benefit of tax-deferred growth, there are no annual contribution limits and distributions are not required to be taken beginning at age 70 ½. But there is a significant downside: the fees. Variable annuities incur a wide range expenses. What’s more, the fees differ among insurance companies and types of variable annuity contracts. Even different share classes of a variable annuity will vary in terms of fees. Some of the most pertinent and commonplace fees and charges for variable annuities are:

• Account Maintenance or Contract Maintenance Charge: An annual fixed fee (e.g., $35) which covers the expenses for issuance and maintenance of the annuity. This fee may be waived in some instances when the account balance reaches a specified dollar amount.

• Administrative: Compensates the company for administration of the annuity such as sending reports to contract holders, processing applications, arranging for fund transfers, accounting and recordkeeping.

• Contingent Deferred Sales Charge (CDSC): Most variable annuities do not apply a front-end sales charge. However, a contingent deferred sales charge is a common feature. In order to discourage early withdrawals or termination of the annuity contract, a sales charge based on a sliding scale is imposed. If a contract holder, for instance, wanted to withdraw from the annuity contract either in part or full within the first year, the sales charge assessed might be 8% on the amount withdrawn in accordance to the scale. If the surrender period is 7 years, then the sales charge would be reduced to zero thereafter. The hefty surrender fees for early withdrawal means locking up your money for a long time which could be a problem for contract holders who need liquid access to their funds. Typically the surrender period is 7-10 years.

• Expense Ratio: The expense ratio is expressed as a percentage of total assets. This fee covers the variable annuity’s management and insurance expenses. The expense ratio can easily be 2% or more! In contrast, mutual fund expense ratios generally tend to be lower because they do not have insurance-related costs.

• Mortality and Expense Risk Charge: One pivotal aspect of variable annuities is the insurance component. Individuals who are primarily interested in a variable annuity as a tax-deferred investment for retirement can easily make the mistake of overlooking this costly feature. The mortality risk charge is equal to a certain percentage of the variable annuity account’s value. It is an annual fee, generally 1.25% (but can be higher). Broadly speaking, the mortality risk charge compensates the insurance company for assuming certain risks under the annuity contract. This M&E risk charge takes into account unexpected current and future situations. An annuitant receiving payments could outlive his or her estimated life expectancy. Another example of the type of risk the insurance company takes is that the death benefits paid can exceed the value of the contract.

• Premium Taxes: Some states and local governments such as municipalities impose premium taxes. The applicable percentage for premium taxes is deducted from each variable annuity premium purchase. The tax varies from 0 to 5% (subject to change).

• Short-Term Trading: To curb short-term trading, a fee may be imposed.

• Transfer Charge: Variable annuities generally allow a specified number of transfers (e.g., 12 transfers) in a given contract year. However, a fee may be assessed on transfers that exceed the allowable minimum.

• Underlying Subaccount Fees: This fee covers expenses related to compensation for investment management, day-to-day operations and administration of the mutual fund subaccounts. These fees differ; anywhere between 0.50% to well over 1%.

And, these are just some of the fees! There also other types of variable annuity fees and charges pertaining to optional benefits which are continually being expanded. Examples of optional benefits: guaranteed minimum income benefit, guaranteed lifetime withdrawal benefit, a step-up death benefit and long-term care insurance. Some insurance companies may offer “bonus credits” which also have a cost. The fee structure and wording in a variable annuity contract is highly technical and detailed. The seeming “benefit” of tax-deferred growth after careful analysis of the variable annuity’s fees in relation to performance may simply not be enough of a lure when stacked against other types of investments such as taxable mutual funds. There are no-load, low-cost variable annuity options and thorough research is required.

Investing in a variable annuity is not as straightforward as it initially appears since multiple factors have to be weighed. A variable annuity is a hybrid financial product which combines various characteristics of insurance, retirement accounts and mutual funds. Whether or not a variable annuity makes sense for you depends on an objective assessment of your personal and financial situation, investment goals, risk tolerance, time horizon, current portfolio including retirement accounts, savings, estate plan and tax bracket.


For informational purposes and not intended as advice. Information current at time of publication.