Issue link: https://resources.envestnet.com/i/1527488
Annuities as an Asset Class for Fee-Based Advisors l 47 © Envestnet 2022 Framing Annuity Fees We have described the fees for different types of annuities, and it is worth returning to this issue. As we noted, fees for fixed annuities are often less and are based on spreads between what the insurer can earn on the assets and what is credited as interest. They must be reverse engineered since there are not always explicit fees beyond those on optional benefits. This discussion is mostly about variable annuities. Their fees are often presented as one of the biggest objections to annuities, and sometimes fixed annuities get caught in that crossfire. Variable annuities have generally come under attack for the higher internal costs relative to an unprotected investment portfolio. It is important to frame the issue of variable annuity fees in terms of the potential value the variable annuity can provide to a retirement income plan. Variable annuities may have higher ongoing charges than non- annuity investment portfolios, but a portion of those fees are to pay for the assurance of a lifetime income in the face of longevity and market risk. It may be easiest to think about the fee issue by comparing to simple income annuities. Income annuities do not include transparent fees, as the fees are internal to the product and the payout rate is provided on a net basis. Money's worth measures can be used to back out the implied fees for an income annuity. But if we frame the income annuity in the same way as a variable annuity, we conclude that the income annuity has a 100 percent fee at the time the contract is signed, and the premium is paid. Once an income annuity is purchased, assets are relinquished to the insurance company and will be inaccessible at any point in the future when the annuitant remains alive (there could be a cash refund provision at death). There is no contract value. In contrast, deferred variable annuities provide liquidity through the contract value. Variable annuity liquidity allows for the guarantee to be ended at any time, returning any remaining assets. Excess distributions are allowed with a proportional reduction to the guarantee. The fee drag will work to gradually reduce the contract value over time rather than eliminating it immediately. In practice, we do not describe the income annuity as having a 100 percent fee. Rather, we focus on the role its guaranteed income can play in the overall financial plan. Variable annuities maintain a contract value which has a higher cost associated with it, but the focus should be on how much must be earmarked to fund different retirement goals. With risk pooling, an income rider may allow fewer assets to be earmarked to meet retirement spending needs, which supports the annuity's value proposition. Also, if fewer assets are needed to comfortably meet the spending goal, then even a higher fee drag on a smaller asset base may not lead to more overall fees.