Annuities, which are insurance products, are an important part of many Americans’ retirement plans because they can offer guaranteed payments. Insurance companies offer annuity contracts, which allow you to pay a premium in exchange for regular payments, and in some cases, investing opportunities. Depending on what stage of life you’re in, payments can begin right away or at some date in the future. Regardless of the type of annuity you choose, though, there are a number of costs that go along with owning it. If you have questions about annuities or their fee schedules, consider speaking with a financial advisor.
The Costs of Annuities
The first thing to know about owning an annuity is that fee schedules vary from company to company. The costs you may encounter to own one such policy may be completely different from what may accompany the same type of annuity at a different provider.
As a general rule of thumb, the more complex an annuity is, the more you can expect to pay to own it. The most valuable way to keep these charges in perspective is to consider them as a whole, representing a percentage of the annuity’s overall value. That’s similar to evaluating the costs of a mutual fund or exchange-traded fund (ETF) through an expense ratio.
With all of this in mind, there are a few common annuity fees and charges you can expect to pay in most situations:
1. Administrative Annual Fees
The most conventional fee you could pay for an annuity is the administrative fee. This is essentially a baseline charge that allows you to maintain ownership of your contract. These fees might cover things like record-keeping, account services and basic management of the annuity.
These fees are often charged either as a percentage of your annuity’s total value or on a flat-rate basis. If the former, rates typically won’t exceed 0.30% of your contract’s value. If your provider uses a flat fee, though, rates range from $50 to $100. Many times, an annuity company will waive your administrative fee if your contract is larger than a predetermined amount.
2. Investment Expense Ratios
When you buy into a variable annuity, your money is tied to an underlying investment. For example, your assets may track the performance of mutual funds, ETFs or index funds. Each of these types of funds carries an expense ratio, which reflects the annual cost of owning the fund. The expense ratio is deducted from the assets you have invested in the fund, making this an indirect cost of owning an annuity. These rates vary wildly, but most won’t exceed 2.5%.
3. Surrender Charges
At any point, you may want to sell some or all of your ownership in an annuity for cash. While this is possible, you’ll likely need to pay a surrender fee to do so. These fees specifically apply to any withdrawals that come before your regular payments are scheduled to begin.
Whether you pay a surrender fee and how much the fee amounts to depends on the terms of your annuity contract. For instance, an insurance company could charge a higher surrender fee if you withdraw money during any of the first 10 years of your contract. Typically speaking, though, insurance companies utilize a declining fee schedule for withdrawal charges. That means that this cost will shrink annually and eventually disappear.
4. Mortality and Expense Risk Charges (M&E)
An annuity is an insurance product, not a security such as a stock or a bond. That means insurers have to hedge the amount of risk they’re inheriting. One way they do that is by charging mortality and expense risk fees. These are designed to guarantee that the cost of providing the annuity to you won’t change even if your mortality risk or life expectancy changes. For the most part, these fees range from 0.50% to 2% of your contract value.
5. Commissions
Commissions are paid to the insurance agent who sells you your annuity contract. This is similar to any other sales commission, like the ones that some fee-based financial advisors can earn for selling a particular investment product. Your insurance company may roll the commission into the contract rather than spell it out in a specific fee schedule.
The more robust your contract’s features are, the higher the commission you’re likely to pay. In turn, fixed annuities usually come with cheaper commissions than, say, a variable annuity that offers a wide selection of investment funds. Even the most expensive contracts don’t exceed a 10% commission, though.
6. Annuity Riders
Each type of annuity comes with a specified set of features that are built to enhance its overall benefit to you, the client. But many insurance companies will provide an additional array of features known as riders. These could affect your contract’s death benefit payout, income payments and a variety of other areas.
While annuity riders are optional, adding them to your contract will cost you an extra fee. These charges can range from fairly insignificant to quite high. So before you decide to accept or deny a rider, figure out how much the added feature will help you out in the long run.
7. Other Fees
Depending on what type of annuity you purchase, there are other fees you might pay. You may encounter a premium tax, which is what an insurance company uses to offset any state or federal taxes they incur when selling the annuity. Other miscellaneous costs include redemption or transfer fees if you decide to sell the annuity to someone else and underwriting or distribution fees when you receive payouts from the annuity.
What Is an Annuity Premium?
In addition to the above fees, there’s also the premium you have to pay to buy into your contract. The required premium amount depends on the value of the annuity contract you want to purchase and the type of annuity. There can also be a difference in how you pay your premium.
A single premium annuity, for example, requires just one payment for funding. So if you’re rolling over an old 401(k) or IRA, you might use the proceeds to purchase an annuity with a single lump sum. An annuity that has a flexible premium may be paid in a series of payments or through a combination of an initial lump sum and ongoing premium payments.
Every insurance company sets its own minimum initial premium rules. While these requirements typically won’t exceed $100,000, the lowest they’ll normally go is $2,500.
How Taxes Affect Annuities
One final category of costs to consider with an annuity is how your payments will be taxed once you begin taking withdrawals. Taxation depends largely on whether you have a qualified or non-qualified annuity.
Qualified annuities are funded with pre-tax dollars and are typically purchased through a tax-advantaged plan, such as a 401(k) or traditional IRA. When you begin taking distributions from the contract at age 59.5 or later, those payouts are taxed at your ordinary income tax rate. A 10% income tax penalty applies to any early withdrawals made prior to age 59.5, unless you qualify for an exception.
Non-qualified annuities are funded with after-tax dollars, similar to a Roth IRA. The difference is that the earnings on your annuity are taxable at your ordinary income tax rate when you withdraw them. The same 10% early withdrawal penalty also applies to these types of annuities. The penalty only affects your earnings, not the principal amount.
The Bottom Line
Annuities can add another stream of income to your retirement plan. However, it’s important to understand the upfront and ongoing costs you’ll be on the hook for. It’s also helpful to look at how costs vary from one type of annuity to another. Make sure to factor in what’s best for both your eventual retirement income needs and your current budget. Of course, it’s also important to make sure you have fully considered equities and fixed-income securities as a means of generating funds for your retirement.
Retirement Planning Tips
- Planning your retirement income on your own is a daunting venture. A financial advisor can help you properly prepare your finances for retirement by helping you choose investments that make sense for your goals. Luckily, finding a financial advisor that can help doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Annuities can supplement other sources of retirement income, such as an IRA or Social Security. If you’re curious as to what you’ll receive from the federal government, stop by our Social Security calculator.
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