Annuity Fees: What’s Legit and What’s Just Cutting Into Your Investment?

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At first glance, annuities may seem like the Swiss Army knife of retirement planning — abounding in helpful features. While they can’t help you open a can in the Alps, they can help provide guaranteed income throughout retirement, offer tax-deferred growth and add protection from market downturns. But like many other useful financial products, these helpful features also come with a variety of fees — some more reasonable than others.

Some of the fees associated with annuities are understandable costs tied to legitimate services. Others, however, exist mainly to pad the insurance company’s coffers while siphoning money from your returns over time. Determining which fees are legitimate and which ones drain your investment can be a real challenge.

Fortunately, GOBankingRates connected with Roland Chow, a financial planner and portfolio manager at Optura Advisors, to learn how to spot the difference between annuity fees that are worth it and those that just make someone else rich.

Understand Some Common Fees

Chow explained that while there are four major types of annuities — immediate, deferred, fixed and variable — not all of them carry the same kinds or levels of fees. However, certain fees are common enough that you should be on the lookout for them and know they’re generally considered fair.

Some annuities may be what Chow calls a “feeless product,” with only a surrender charge, which functions like an early withdrawal penalty. “A surrender charge is therefore a surrender penalty if the annuity were to be canceled early and the principal redeemed,” he said.

“Mortality and expense (M&E) charges are typically found in variable annuities, where they are used to cover costs associated with the company providing lifetime income for the client,” he said. “For example, if a client lives a long time — and at the same time is collecting a lifetime income from the annuity company — that lifetime payout represents a risk and liability for the annuity company.” He added that the company will assess an expense to hedge its risk in providing that lifetime benefit.

Chow said investors can also expect to see administrative fees related to the general management of the contract, such as customer service and recordkeeping.

Be Aware of Investment-Related Costs

While searching for annuities that could be right for you, you might encounter investment-related fees and costs. Chow said you’ll typically find these in variable annuities, where growth is tied to market performance.

“These market investments are most often equity and bond mutual funds,” he said. “The equity and bond mutual funds typically have fees just like normal mutual funds, where the fees can be loaded in different ways.”

He advises investors to stay particularly mindful of the fees in the variable annuity family. Sometimes, you can find three layers of fees — one for the annuity itself, another for the investments inside it, and a third for additional riders and benefits.

“Contrast this with annuities in the fixed-index annuity family,” he said. “Often, those fees are embedded and the numbers are netted out, so at least the purchaser knows what to expect.”

Know Your Riders

Riders are special features typically added to a base annuity contract to provide additional benefits. Not all riders are created equal, and different kinds of riders have distinct functions. Chow gives two examples: a guaranteed lifetime income rider and an index return multiplier.

“A guaranteed lifetime income would be a rider that allows the annuitant to take an income that will last their entire life,” he said. “Normally, the guaranteed lifetime income rider would continue to pay out even if the principal funding the annuity contract is now zero.”

Chow calls this a powerful planning feature, since it allows you to create a situation where you essentially build your own private pension — receiving a regular check for the rest of your life and never running out of income.

He also advises being mindful of the index return multiplier; if added to the annuity, this rider ensures that returns earned can be multiplied by a higher amount.

“To determine whether riders are worth the cost, find a competent advisor who can walk you through the trade-offs considering your specific situation, as the decision should be based on a very personalized conversation,” he said.

The Impact of Fees on Growth

Sure, fees can create a drag on growth, but Chow said that in some cases, they can also provide valuable protection or enhanced income potential.

“It really depends on what the fee is and what the client is getting for that additional fee,” he said. “Sometimes, especially in variable annuities, there are additional fees to pay for extra security, like protection of principal — and that’s a valid consideration even though it creates more drag on growth.” 

With other annuity types, principal protection is built in — meaning there’s no need to pay an additional fee for it. 

Your Best Bet: Work With an Advisor 

Chow acknowledges that this is a lot of information to process, and your decision-making should be rooted in your unique financial circumstances. He strongly encourages you to work with a licensed financial advisor you trust. 

“It’s important to work with a competent advisor who can represent multiple annuity companies and has the knowledge and tools to evaluate what the ideal annuity is for the client when they’re ready to purchase,” he said. “With the right contract for their situation, many clients may come to realize that annuities are one of the most powerful financial vehicles.”

This article is part of GOBankingRates’ Top 100 Money Experts series, where we spotlight expert answers to the biggest financial questions Americans are asking. Have a question of your own? Share it on our hub — and you’ll be entered for a chance to win $500.

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