Issue link: https://resources.envestnet.com/i/1527488
Annuities as an Asset Class for Fee-Based Advisors l 32 © Envestnet 2022 Fees Providing a guaranteed lifetime withdrawal benefit is a risky endeavor for the insurance company. The insurance company is obligated to provide lifetime income payments at the guaranteed level if the underlying assets held within the annuity have been depleted. Variable annuities with living benefits require managing market risk in addition to longevity risk. For FIAs, because of principal protection, the rider fees for living benefits only need manage longevity risk. The greater the investment volatility and the higher the guaranteed withdrawals that the insurance company allows, the greater is the cost for creating a risk management framework to support that guarantee. When people mention that annuities have high fees, they generally have variable annuities in mind. Deferred variable annuities generally have several types of ongoing fees. The first relate to the underlying funds expenses that would be included with any mutual fund investment. The only issue to consider here is whether the funds within the subaccounts have elevated fees due to the inclusion of 12b-1 fees in their expense ratios, and whether investment options available to the individual outside of the variable annuity also include 12b-1 fees. These fund fees are charged on the contract value of underlying assets. The second type of fee relates to mortality and expense charges for the insurance company. These fees help to support the risk pooling and business costs of the insurance company as well as a basic annuity death benefit. These fees are also generally charged on the contract value. A third type of fee that may exist in the short run are contingent deferred sales charges (or surrender charges) for those seeking non-lifetime distributions above the allowed levels in the early years of the contract. Surrender charges receive much of the criticism related to the fee levels for annuities. Deferred annuities are liquid in that they may be surrendered with the contract value returned as an excess distribution above the guaranteed distribution level. But in the early years of the contract, surrender charges may limit the portion that can be returned without paying a fee. For instance, surrender charges could work on a sliding scale basis starting at 7 percent in the first year the annuity is held, and then gradually reducing by 1 percent a year down to zero after the seventh year that the annuity is held. In this case, after the seventh year the surrender charges end, and the contract value will be fully liquid in all subsequent years. Deferred annuities are meant to be long-term holdings and surrender charges help to recoup the fixed set-up costs to the insurer for those who leave early. © Envestnet 2022