Annuities, as an investment vehicle, can be unwieldy beasts. Nevertheless, we've detailed the ins and outs of annuities in articles covering when annuities make sense, what you need to know before you buy, and why it's smart to pick the simplest annuity.

One thing we haven't done, though, is take a deep dive into the fees that come with annuities. Annuity fees are almost always complicated, opaque, and steep, so it's important for every investor to thoroughly understand what they're getting into.

Here's a look at how you can identify the fees associated with an annuity based on an analysis of a specific contract: the deferred variable annuity.

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Where to begin

There are many articles out there making claims about the total fees annuities charge -- my colleague Selena Maranjian notes the average is an unsightly 2.3% of the contract value. However, there are few, if any, articles that break down how to identify all of the fees on your own.

For unacquainted investors who are looking at annuities as potential investments, a good way to start is to read this article and then ask the annuity salesperson to lay out each and every fee, charge, or expense involved over the life of the contract. This is likely to be a demanding exercise, but you have the list below to ensure your annuity salesperson is covering all the bases.

If you're holding an annuity today, then use this article as a reference while you to dig into your contract and pinpoint every fee that your investment carries. I'll warn you right now that the example chosen is not so pretty.

Even when you know the names of these fees, they can be difficult to find. The contract I'm referencing for this article is a deferred variable annuity contract with a guaranteed minimum income benefit (GMIB). This particular annuity has three defining characteristics, all embedded in the name:

  1. Deferred means it does not start paying out immediately, but will begin to at a contract-defined point in the future.
  2. Variable means payments will depend on the amount you contribute and the performance of the underlying investments. The market, in other words, can cause a varied outcome.
  3. Guaranteed minimum income benefit means the annuity holder will receive a guaranteed minimum rate of return on the principal, regardless of market performance. Similar features include guaranteed minimum accumulation benefit (GMAB) and guaranteed minimum withdrawal benefit (GMWB).

As you can see, this particular annuity has some bells and whistles that make it more or less comprehensive of the fees you may encounter. Other well-known contracts include "deferred fixed" and "fixed income" annuities. For the definitions of each of these, this article is a helpful reference.

There's a key thing to be aware of when looking through your paperwork. First off, be aware that without your paperwork, it's much more difficult to find all the fees. In marketing materials, there seems to be selective disclosure, if any.

Second, your paperwork will contain both generic information and information specific to your annuity. The latter can sometimes be called the "data pages." The "data pages" are a treasure trove of information on fees -- if you're willing to dig.

Without further ado, here's a rundown of fees that could be part of an annuity contract.

General fees

General fees are fees that are part of every annuity. I can't say whether the industry refers to them as such, but nearly everyone levies them on clients. They tend to have names like "operations," "administration," or "distribution" fees, and they represent the costs of setting up and managing the annuity contract throughout its duration.

General fees are measured in percentage terms of the total account value (as are all percentage-based fees mentioned). Here's a real-world example of what those fees could amount to, based on a current prospectus for a variable annuity contract from Axa Equitable Life Insurance Company:

Type of General Fee Annual Rate
Operations fee 0.80% to 1.05%
Administration fee 0.30% to 0.35%
Distribution fee 0.20% to 0.25%

When you add them all up, the total contract fee will likely come to 1.3% to 1.65% of the total contract value.

Investment management fees

Variable annuities, as mentioned above, have underlying funds that are invested in the stock market. For the management of those funds, there are investment management fees.

These funds could include mutual funds or exchange-traded funds that track a market index. You'll see the fees they charge referred to as "expense ratios," "12b-1 fees," or "service fees," which the Axa example above states will range from 0.59% for an index fund to a whopping 3.14% for a pricey mutual fund. The high end of that range can be offset by "fee waivers and/or expense reimbursements," which could bring that eye-watering fee down from the stratosphere to 1.20%.

Simple? I think not.

Riders

Beyond the general fees and investment management fees, there are special "add-ons" to annuities that come with an extra charge. These include extras like a guaranteed minimum income benefit (GMIB), which is a minimum amount the insurance company will pay you, regardless of the performance of your annuity.

There are variations on the GMIB that could be reflected in acronyms like "GRIP," "GIA," "RIG," and "MAP." It may also be called an "Income Guard." Each of these is more broadly classified as a benefit "rider," meaning it's a special attachment to the annuity itself.

The fees on riders are more difficult to assess because they're only applicable to a portion of the contract value that could be referred to as the "benefit base." That base can vary based on what you commit to in your contract negotiation. For the purposes of our example, we'll assume the benefit base is 50% of the contract value.

In any case, a typical charge for the rider attachment is anywhere from 1.15% to 2.30% of that benefit base.

How it all adds up

All told, these three major components add up quickly. Combined, annual fees can tally anywhere from 2.46% to nearly 6%!

Type of Fee Low End High End
General fees 1.30% 1.65%
Investment Management fees 0.59% 3.14%
Riders (example is 50% of contract value) 0.57% 1.15%
Fee total 2.46% 5.94%

Note: Rider applied to 50% of contract value. It could be more or less depending on client's directive on how much of the benefit base to protect, so I presented a down-the-middle scenario.

If you thought mutual funds had a bad rap for high fees, brace yourself for annuities. What the fees above can do to your savings is nausea-inducing.

Let's consider some of the long-run consequences of these fees, assuming you're paying a total of 4.2% on an annuity that's worth $100,000 and earns 6% annually for 10 years:

  • Investment value at end without fees: $447,712
  • Investment value at end with fees: $328,330
  • Amount surrendered to fees: $119,382
  • Reduction in value due to fees: 26.7%

The bottom line

As you can see, there's a reason we've recommended that annuity investors keep things simple. Digging through the fees in an annuity contract is no easy task, and I've left off some of the exceptional ones, which also can be the hardest-hitting. Those would include the "withdrawal charge," which ensures that clients are locked into the contract for anywhere from five to seven years. If a client needs to terminate the contract for one reason or another, they'll need to pay a one-time fee that can reach up to 7% of the total contributions paid into the contract.

Because the withdrawal charge is not part of the ongoing fees, I've excluded it. I've done the same with things like "transfer charge," "administrative charge," "distribution charge," "third party transfer charge," "charge for taxes," "contract fee," "redemption fee." That doesn't mean you shouldn't suss those out before purchasing, or even after the fact, to be fully aware of what you're paying.

Deferred variable annuities like this one can be costly in the long run. As an investor, you're essentially handing over your savings to a company that promises to pay you a stream of income for life. For that privilege, you'll pay more fees -- and bigger fees -- than a vanilla dividend index fund charges.

Add in the inflationary effects on a fixed income stream, and annuities become an even tougher pill to swallow.

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