Variable annuities offer investors a numberof benefits, including tax-deferred growth,creditor protection in some states, and variousliving and death benefits (eg, the beneficiary of a variable annuity never receives less than thecost basis of the annuity minus any withdrawals).However, many of these benefits don't come without aprice. You should know the costs associated with variableannuities before you decide to buy one.
Average Annuity Costs
There are several types of expenses associatedwith a variable annuity. Besides the mortality andexpense fee, administration fee, and distributioncharge, there are front-end loads, annual contractcharges, surrender penalties, and subaccount expenses.Before you purchase an annuity, you should try toreduce or eliminate as many of these charges as possible.The IRS imposes an additional penalty forearly withdrawal from an annuity prior to age 59 1/2.The annuity contract may also impose penalties foran annuitant's early surrender.
As you can see, unless you are a disciplined investorand don't plan on taking money out of the annuity forseveral years, you shouldn't consider the purchase of avariable annuity. However, a variable annuity can be agood investment vehicle for some investors. For example,if you are a disciplined investor, live in a statewhere creditor protection is afforded the cash accumulationin an annuity, and have need of tax deferral, youmight want to consider a variable annuity. In this case,it's worth a serious look.
Sound Selection Process
If you decide an annuity is right for you, select aninsurance company whose annuities offer a variety ofinvestment subaccount choices with several differentmoney managers. In addition, try to minimize the mortalityand administration expensesâ€”these expensesalone average 1.25% to 1.40% annually. Be aware thatthere are annuities out there that do not have surrendercharges for early withdrawal. These annuities are commonlyreferred to as no-load annuities, which areoffered by many insurance companies.
You may not be familiar with no-load annuities.Many financial planners opt to sell annuity contractsthat have surrender periods (usually between 4 and 8years). That's because annuities that have penalties forearly surrender and/or withdrawal typically generatehandsome commissions for the financial planners whosell them. In most cases, commissions range from 5%to 8% of the amount deposited into the annuity. Noloadannuities generally pay little or no commission tothe financial planners who sell them.
Many financial planners who sell no-load annuitiescharge clients an asset-based management fee. This feecovers the cost of advising investors on an ongoingbasis how to allocate the monies in the annuity amongthe different available subaccounts. An important factorto remember about no-load annuities is that theyoffer much more liquidity than other annuities. Note:There are many annuity contracts available that havemortality expense fees that are less than 1%, asopposed to the typical 1.25% to 1.40% fee.
Of course, there are other living and death benefitoptions available within an annuity contract that I havenot discussed. Because they have additional feesattached to them, these additional options will drive upthe annual costs of the annuity. Before youcommit yourself to purchasing an annuity contract,study the insurance company's annuity prospectus. Youwant to know exactly what the real costs are of purchasingthe contract under consideration. Know thedeal before you sign the contract.
Thomas R. Kosky and his partner, Harris L.Kerker, are principals of the Asset PlanningGroup in Miami, Fla, specializing in investment,retirement, and estate planning. He teaches corporatefinance in the Saturday Executive andHealth Care Executive MBA Programs at theUniversity of Miami.