High Variable Annuity fees have been a hot topic over the past 20 years. In the 90s no one cared because stocks were rising 20% per year. It wasn’t until the mid 2000s that these products came under severe scrutiny.
Coupled with the mis-representing of income guarantees, variable annuity fees drew tremendous regulatory action. In some cases large fines were imposed. In others, people were barred from the industry. And major companies received disciplinary action.
Are Annuities Smart Planning Tools or a Financial Trap?
For years financial advisors have recommended variable annuities as a one stop solution for a variety of client concerns. Afraid of losing your principal? Covered. Afraid of running out of money? Covered. Want to earn a stock market return with less risk? Covered. But the cost of these feel good solutions may be too high.
The fees on some of these variable annuity products approximate 4% (!!) all in. And at that level, the chance of “market returns” becomes much less likely. Lets cover a few of the “attractions” in detail and the alternative.
Principal protection and stock market returns with low risk
Many of these products no longer offer full principal protection. But the ones that do often limit investment options to a “balanced” type portfolio consisting of a high level of bonds.
With a 3-4% fee, the bonds are earning almost nothing. And with a long term average return on stocks of 8-10% (depending what you mean by “long term”), your stock portion earns 4-6% after fees.
So with part of your portfolio netting close to 0, and the other part earning 4-6% by my estimates, why not just buy a CD or fixed annuity?
Never run out of money
Here’s the pitch. If you choose a Guaranteed Minimum Withdrawal Benefit or Income Benefit (GMWB, GMIB), which is what these riders are typically called, you will get a guaranteed annual sum that you can withdraw. Or you receive a guaranteed annual income which will never stop. Regardless if the stock market goes up or crashes.
This feature indeed sounds attractive. But does it make the high variable annuity fees worth it? I have modeled an equivalent strategy using a fixed annuity (an annuity that typically pays a fixed rate of interest) followed by an immediate annuity (an annuity that converts a lump sum to a pension-like payment for life or certain number of years). That strategy offers as much if not more flexibility and an arguably better outcome for the investor.
With interest rates at historic lows, it behooves the fixed income investor to stay flexible in my opinion. Meaning It’s not the time to lock up the money for 20 years! Or pay the high variable annuity fees for that privilege!
Another Alternative to high variable annuity fees?
Yes there is. The advisor annuity. Pioneered mainly by a company called Jefferson National, this product is appearing more frequently now in the stables of other annuity companies. Lincoln Financial now offers one and Security Benefit does too. Both have created a product to help clients reduce the variable annuity fees they are currently paying (list of companies not exhaustive).
These annuities typically offer a low fixed cost and lower cost investment options (such as funds by Vanguard). They keep the overall fees much lower than a traditional variable annuity.
For example, in a recent case, a client came to us with an annuity that charged fees over 4% all in. M&E expense = 1.4%. Income and death benefit riders totaled 2.3%. And the und fees varied from 0.36% to over 2.2%. On a $100,000 account, that means fees OVER $4,000/year! A switch to an advisor annuity could lower their fees by over 90%.
Update: See the Department of Labor blast a high fee annuity in their April 6, 2016 press conference announcing their new fiduciary rule:
The key is that these annuities offer no “death benefits” or “income benefits.” These are typically what cost so much money. They also offer lower fee funds with fees below 0.50%. But what if you still want those income benefits?
Low Fee Annuity AND Income Benefit
Companies are always trying to create niches for themselves. By offering options in all shapes and sizes, investors can find many options in the marketplace. For example, Lincoln Financial recently unveiled a lower cost advisor annuity that also offers an income benefit option.
The cost of that option isn’t much different than it is at other annuity companies in my opinion. But other costs are stripped out. Therefore, if it’s the income benefit you want without extra fees, then companies like Lincoln may offer the solution for your investment dollars.
How to Choose
The first question you have to ask yourself is this. Why you are in an annuity in the first place? In my experience, the annuities with all of the guarantees have appealed to people who:
- have a lump sum of money such as one big (for them) IRA account.
- have a lump sum that represents not only a large majority of their entire savings but also a major source of their retirement income.
- And therefore are very scared to lose anything.
However, if the annuity is a smaller portion of your wealth or you do not fear market volatility, then it may make sense to rethink your strategy. And consider transferring those funds to a lower cost advisor annuity or a fixed annuity (via a 1035 exchange) depending on your goals.
Do you do fear market volatility? And because of that do the guarantees sounded appealing to you? Then you may want to explore fixed annuities or other guaranteed forms of investing. Here a 1035 exchange would also allow you to transfer your funds without paying taxes on the earnings, to another annuity.
What’s Most Important
Most importantly though, if you are clear about your goals, and clear about the steps that will get you to those goals, then you should approach your selection of suitable financial products with these goals in mind.
It’s my opinion that oftentimes, you will do better financially without paying high variable annuity fees (did I mention that the agent that sold it probably earned a 7% commission?). Learn about what you own and the fees. You can easily find the annuity prospectus outlining the fees online (just use a google search).
And make an intelligent decision with the facts in hand.
Have a question about your annuity and whether it still fits into YOUR financial plan? Wondering if the variable annuity fees you’re paying are too much? Give us a call or drop us a note here:
Thanks for reading!
Disclosures: Neither I nor our firm WHA get paid any advertising or promotion dollars from companies mentioned in this article. This article is not meant to be taken as advice about something you should do. But rather as ideas to consider when making your own decisions with your personal advisor. Note – if it wasn’t obvious already, we do recommend advisor annuities to our clients when appropriate and generally are not fans of paying high variable annuity fees.