Annuities are insurance products issued by insurance companies. They were created to help people build retirement savings and generate retirement income. As insurance products, annuities offer the advantage of benefit certainty, which means they deliver guaranteed and predictable benefits — whether that’s a guaranteed interest rate on savings for a specified time period or the assurance of guaranteed income payments for as long as one lives.1
In an era of increasing longevity where many Americans are concerned about retirement security — only about three in ten (29%) say they are very confident they won’t outlive their money2 — the value annuities provide should not be overlooked or discounted.
As with any financial product, it’s important to understand how costs are reflected in the design. Annuity costs fall into three basic categories: implicit costs, explicit costs, and activity-driven charges. Annuities can have a combination of these costs, as shown below.
These are costs that are built into the product’s underlying design and are not directly charged to the annuity owner. Annuities that have implicit costs are often referred to as spread products. With a spread product, an insurance company generally makes its money through the “spread,” that is, the difference between the interest earned by the insurance company and the interest rate and benefits credited to the annuity owner.
It’s important to recognize that not all annuities have explicit costs — it really depends on the annuity type and the benefits offered. Explicit costs typically take the form of a fee or charge that the annuity owner pays. They may, for example, be reflected as a dollar amount or a percentage of assets. Examples of explicit costs that may apply include:
- Base contract fee: Covers the insurance company’s risk of providing guaranteed benefits, such as a guaranteed death benefit and annuity income options for lifetime income.
- Contract maintenance fee: Covers the insurance company’s cost of administering and servicing the annuity.
- Investment fees and expenses: Covers the portfolio management and investment-related costs associated with the annuity’s investment options (if applicable).
- Guaranteed living benefit fee:3 Covers the cost associated with providing the guaranteed living benefit (if offered).
- Enhanced death benefit fee:3 Covers the cost associated with providing the enhanced level of beneficiary protection (if offered).
- Asset management fee (generally applies to “fee-based” annuities only): Covers the Registered Investment Advisor’s services for ongoing service and support.
- Premium-based charge/upfront sales charge: While not commonly used, some variable annuities may have a premium-based sales charge or upfront sales charge that is deducted from the initial premium at purchase or over an extended period of time.
Some annuity costs are driven by the annuity owner’s activity. We refer to these as activity-driven charges, which may include:
- Early withdrawal charge or surrender charge: Applies if money is withdrawn early, beyond any “free withdrawal” provision that may be offered. This charge is usually in place for a set number of years after purchase and generally declines over time. It’s designed to help offset the internal costs the insurance company incurs in marketing and distributing the annuity, such as commissions it pays, in the event the annuity owner takes their money out early. Note: Fee-based annuities, referenced earlier, generally do not have an early withdrawal charge or surrender charge.
- Market value adjustment: Certain types of annuities also include a market value adjustment if money is withdrawn early. This adjustment reflects changes in interest rates in the marketplace since the time of the annuity purchase, potentially increasing or decreasing the withdrawal amount.
- Additional 10% federal tax for pre-59½ withdrawals: Although it’s not an insurance company-imposed cost, it’s important to know that because annuities receive certain tax advantages, such as tax deferral,4 if withdrawals are taken prior to age 59½, an additional 10% federal tax generally applies to taxable amounts withdrawn.5
Annuities can be offered by financial professionals who are paid a commission by the insurance company. The cost associated with paying a financial professional is generally an implicit cost. However, some annuities (known as “fee-based” annuities) offered by Registered Investment Advisors (RIAs) may be subject to an ongoing asset management fee, which is an explicit cost that the annuity owner would pay.
Annuities can have a combination of implicit costs, explicit costs, and activity-driven charges, as shown below. To learn more about the benefits and costs associated with a specific annuity product, people considering an annuity should ask a financial professional for complete details, including a prospectus, if available.
Information above is general and for educational purposes only. Annuity features, benefits, terminology and costs can vary from insurance company to insurance company and product to product and may be different than what is shown above.
