Hidden costs in Annuity investing

Strategies for under-performing annuities

Understanding the costs behind the fine print

You make a fortune on the headline, but the fine print takes it all away. Well, you can consider this a joke, or rather, the reality on annuity investing. Lets explore the truth behind this.

Strategies for under-performing annuities and recourse for investors:

Can you dump those underperforming annuities or cash out for your urgent needs? Lets see some ways to do this, and what is your recourse when you feel you are duped.

Well, there are more myths surrounding this investment class than any other form. I’m sure most of you with some money to put aside have at some point in time have considered investing in annuities, or you’ve been approached by a salesman or financial advisor trying to sell you these. But for sure, this is an investment that is very easy to get into, but when all is said and done, very difficult to get out of without paying some form of penalty.

Now what is this annuity? By definition, an annuity is a contract between the investor and the insurance company. There are various types of annuities: single premium deferred annuity, immediate annuity, variable annuity, index annuity, and tax- sheltered annuity. Depending upon the type of annuity, the type of guarantee given by the insurance company would vary.

Briefly, lets see what each of these annuities is in simple English:

A single premium deferred annuity: This allows you to make a single premium, or lump sum taxes are deferred or postponed until money is Withdrawn guarantees specific interest rate for a specific period of time.

A single premium immediate annuity: This allows you to pay a lump sum to the insurance company, that has guaranteed an Immediate fixed income for the rest of your life in some cases, continuing for a certain period to beneficiaries, even after death.

Both these sound very good, but whats the catch? You must sign over all the money you have deposited in the annuity to the Insurance company with full knowledge that you will never be able to touch the money again except for the monthly income. That is a single premium annuity in simple words.

Variable annuities are commonly called mutual funds with an insurance wrapper.

It is a 2-in-1 package sold by an insurance company combining the characteristics of a fixed annuity with the benefits of owning mutual funds. You purchase a variable annuity contract by making a single purchase payment or series of purchase payments. A variable annuity offers a range of investment options. The value of investment will vary depending on the performance of the investment options chosen.

Investment options for variable annuities are typically mutual funds that invest in stocks, bonds, money market instruments, or a combination of the 3. You could allocate any percentage you want among the available funds. For example, you could allocate 40% to equity-based funds, and the rest of the 60% to fixed-income based funds. It is your choice. So, it is extremely important for you to avail the prospectus of the underlying mutual funds and thoroughly study them before you commit your funds.

An index annuity is a contract with an insurance company for a specific period of time. The surrender period of an index annuity is usually about 7 to 10 years. The index annuity tracks an index such as the S&P 500 index, and the return on your money is usually a percentage of the particular index for the corresponding investment year.


I’m going to take the example of variable annuity to explain the charges and costs involved. All annuities come with one form of cost or another. Quite naturally, these charges will not only reduce the value on the return of your investment but also often decrease your invested principal as well.

The most common of these charges are the following:

Surrender Charges

If you withdraw money from a variable annuity within a certain period, the insurance company will levy a surrender charge. This is a sales charge paid to your financial advisor or broker for selling you the annuity.

It is usually a percentage of the amount withdrawn and declines gradually over several years, known as the surrender period. For example, a 7% might apply in the first year after a purchase payment, a 6% charge in the second, a 5% charge in the third year, and so on until the last year when the surrender charge no longer applies.

Often, contracts will allow you to withdraw a part of your account value each year, that is, 10 percent or 15 percent of your account value without paying a surrender charge.

Surrender Charges (example)

Variable Annuity Purchase Payment: $20,000
Schedule of Surrender Charges Declining by 1% Each Year:
Surrender Charge Year 1: 8%
Surrender Charge Year 2: 7%
Surrender Charge Year 9: 0%
10% withdrawal free of charges: $2,000
If you withdraw $10,000 in the first year you would pay a surrender charge of 8% on $8,000 =$640

Let us take an example: You purchase a variable annuity contract with a $20,000 purchase payment. The contract has a schedule of surrender charges beginning with an 8% charge in the first year and declining 1% each year. Now envision you can withdraw 10% of your account value each year, free of charges. In the first year, you decide to withdraw $10,000, or one half of your total account value of $20,000. Here, we are assuming that your contract value has not increased or decreased because of investment performance. In this case, you could withdraw $2,000, that is, 10% of the contract value, free of surrender charges, but on the rest of the sum withdrawn, that is, $8,000, you would be charged 8%, or $640.

Mortality and expense risk charge

This charge is equal to a certain percentage of your account value, typically, around 1.25% a year. This charge compensates the insurance company for insurance risks that it assumes under the annuity contract. Profit from the mortality and expense risk charge is sometimes used to pay commissions to your financial professional for selling you the variable annuity.

Mortality and expense risk charge (example)

Variable Annuity: $50,000

Mortality and expense risk charge: 1.25% of account value

You would pay a Mortality and expense risk charge of $625

Profit from the mortality and expense risk charge is sometimes used to pay commissions to your financial professional for selling you a variable annuity. For example, your mortality and expense risk charge are at the annual rate of 1.25% of your account value.

Your average account value would be $50,000. So, here you’ll pay $625 in mortality and expense risk charges.

Administrative Fees

The insurer may deduct charges to cover record keeping and other administrative expenses. This may be charged as a flat account maintenance fee of $25 or $30 per annum or as a percentage of your account value.

Administrative Fees (example)

Variable Annuity: $100,000
Administrative Fees: 0.15% of account value
You pay administrative fees of $150

For example, your variable annuity administrative fees are at an annual rate 0.15% of your account value. Your average account value that year is $100,000, so you will pay $150 in administrative fees that year.

Additional Fees

Then there are underlying fund expenses, here you’ll also undoubtedly pay fees and expenses that are imposed by mutual funds that are underlying investment options for your variable annuity. Further, you’ll have to pay fees and charges for other features, these are special features offered by some variable annuities such as:

  • Stepped-up death benefit
  • Guaranteed minimum income benefit
  • Long-term care insurance

These often carry additional fees and charges.

Some insurance companies are now enticing investors by offering variable annuity contracts with bonus credit features. These contracts promise to add a bonus to your contract value based on a specified percentage normally ranging from 1% to 5% of the purchase payment. For example, you purchase a variable annuity contract that offers a bonus credit of 5% on each purchase payment. You make a purchase payment of $10,000. The insurance company issuing the contract adds a bonus of $500 to your account. But is there any free lunch offered especially in the world of money? Never.So here’s the catch:

Variable annuities with bonus credits carry higher expenses that can far outweigh the bonus credits offered.

Quite often, you’ll be charged for bonus credits offered in one or more of the following ways:

  • First of all, the surrender charges may be higher for a variable annuity that pays a bonus credit than for a similar contract with no bonus credit.
  • Secondly, the purchase payment may be subject to surrender charges for a longer period than they would with a similar contract with no bonus credit.
  • Thirdly, higher annual mortality and expense charges may be deducted for a variable annuity that pays you a bonus credit.

Although the difference may seem small, over time it can add up. In addition, some contracts may impose a separate fee set up specifically to pay for the bonus credit.

Before purchasing a variable annuity with a bonus credit, ask your financial professional who is trying to sell you the contract whether the bonus is worth more to you than any increased charges you will pay for the bonus. Here you also need to consider the other features of the annuity to determine if it’s a good investment for you.

Apart from all the charges I discussed earlier, other charges such as initial sales loads are fees for transferring part of your account from one investment option to another may also apply. It is very important that before you invest you ask your financial professional right at the onset to explain to you all the charges that may apply. You can also find a description of the charges in the prospectus for any variable annuity that you are considering, and you must make it a point to read the fine print.

Caution! (Source

Other investment vehicles, such as IRAs and employer-sponsored 401(k) plans, also may provide you with tax-deferred growth and other tax advantages. For most investors, it will be advantageous to make the maximum allowable contributions to IRAs and 401(k) plans before investing in a variable annuity.

In addition, if you are investing in a variable annuity through a tax-advantaged retirement plan (such as a 401(k) plan or IRA), you will get no additional tax advantage from the variable annuity. Under these circumstances, consider buying a variable annuity only if it makes sense because of the annuity’s other features, such as lifetime income payments and death benefit protection. The tax rules that apply to variable annuities can be complicated before investing, you may want to consult a tax adviser about the tax consequences to you of investing in a variable annuity.

Click on the video links provided on the side bar of this page to watch a detailed representation of all the hidden fees and costs you might be paying on your hard-earned assets by investing in annuities!