Variable Annuity Fees You Don’t Know You are Paying
Posted by: Michael Zhuang on: March 18, 2011
Invest in a Variable Annuity
Recently, a client of mine brought me the variable annuity he bought a few years ago.
Prominently displayed on the first page are the benefits of the annuity:
Death Benefit: Enhanced Guaranteed Minimum Death Benefit
Living Benefit: Lincoln Lifetime Income Advantage
as well as the fact that the money will earn an fixed annualized rate of 5.75%. Under the bold ACCOUNT FEE subtitle, it states: Account fee is $35 per contract year.
Up to this point, what impressions do you get? If you are like me, you would think it is a phenomenally low cost product that gives great returns with many extra benefits. Aha, guess who wants you to think that way? the insurance company and the agent who sell you this product. If only you just read on, you will find the skeleton, in fact many skeletons, in the closet:
1. The fixed interest rate of 5.75% only applies for the first month, after that, it will be 1.75% .
2. Mortality and Expense (M&E) charges are between 1.4% and 2.4%
3. The death benefit charge is 1.9%.
4. The rider charge is between 0.75% and 1.5%.
5. The living benefit costs 0.75% initially, but there is no cap on how high it can go.
6. The underlying fund expense is between 0.3% and 1.75%.
7. The surrender charge is 8% for the first three years.
In his wildest nightmare, my client did not imagine the total cost would be more than 2%. In actuality, it is 6% and up. These charges are not disclosed in one places, they are scattered in different pages of the contract. No wonder my client did not find them.
Most people hate to read insurance contracts: there is a confusing array of terminology and legal jargons that would make a lawyer blush. Also they think the government is watching anyway, so why bother. What they don’t know is: annuity and life insurance products are not under the purview of the SEC. They are private contracts between you and the insurance companies. Since insurance companies write the contracts you don’t read, guess who will come out ahead?
My advice: read before you sign. If you’d rather read Sports Illustrated, at least hire a fee-only financial advisor to read it for you. Why fee-only? They are not taking money from the insurance companies; chances are they will give unbiased advice.
If you have already purchased an annuity or life insurance contract, it still behooves you to understand the true costs and benefits of the contract. My 2nd Opinion Financial Review service will help you do that.
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Answer to a Skeptical Comment
17 Responses to "Variable Annuity Fees You Don’t Know You are Paying"
April 1, 2011 at 6:13 pm
About the guarantees insurance cos provide, I have another post where the guarantee is only 64% of the premium value. If the insurance cos can’t even deliver that, they can always go bankrupt or get another tax payer bailout.
April 3, 2011 at 10:52 am
You continue to hit the nail on the head with these missives. I found this one to be especially well written and effective. Nice job!
April 4, 2011 at 6:51 pm
I’m all for putting numbers out there so people know and understand the truth but your numbers are so off they don’t come close to making sense. The death benefit number looked really high (my mother has a contract with a competing company) so I checked the Lincoln’s website and other sources and it is .25%, not 1.9% and their max M&E charge is 1.65%, not 2.4% so please read carefully and do research before you post incorrect numbers on your site. With two Masters you should be able to figure this out. Maybe you could put what you read on the site so we could see the actual numbers?
April 5, 2011 at 7:57 pm
David,
First of all, I’d like to thank you for being skeptical. If most investors are like you, they won’t be taken for a ride by the insurance companies and agents.
Since you read from their web site that their max M&E is 1.65%. I took a picture of one page from the middle of the contract the read:
“Maximum Mortality and Expense Risk and Administrative Charges: 2.45%”
Did I not read it correctly that the max M&E is 2.45%? Please enlighten.
April 23, 2011 at 9:07 pm
David…I await your response. I have bookmarked this page and I hope you will respond!
August 25, 2011 at 1:58 am
You sir have done nothing but demonstrate your ignorance by double counting and misrepresenting fees. You obviously have an agenda and it certainly is not an agenda that is aimed at the truth.
August 25, 2011 at 8:55 pm
Please be specific, where am I double counting and misrepresenting. My agenda is very simple: ordinary investors should avoid complicated financial products; if they have to, at least read and understand the whole contract. You have a problem with that?
December 1, 2011 at 10:14 pm
You refer to VA’s not being regulated by the SEC. This is true. They are regulated by FINRA. They are also regulated by each of the 50 States. Before they can be sold in a state that state scrutinizes them very carefully during the approval process. That process often takes 6 months to a year.
As far as costs are concerned, ask many investors who bought one of these in mid summer 2007 how glad they are to have had the guaranteed accumulation and withdrawal guarantees. They would probably feel that the charges were well worth it.
December 23, 2011 at 9:14 pm
To Art,
1. FINRA is a company (FINRA, Inc.), not a government regulatory agency, so it can not regulate the industry in any legal sense. In fact, FINRA has a membership list made up of other companies that sell annuities, stocks, and insurance. See http://www.finra.org/AboutFINRA/MemberFirms/ListOfMembers/P012908 I would call that “setting the fox to guard the hen house”. Good for the fox, not so good for the hens.
2. As far as the states regulating the insurance industry, well, each state has its own set of laws. Some are comprehensive, so less so, and some are downright inadequate. This is the same reason why so many large financial services companies have headquarters in certain states (Connecticut, Delaware, and South Dakota come to mind). The laws in those states are so “business-friendly” that consumers should be ready to … well, bring their own protection. In any case, pitting a small under-staffed underpaid insurance commissioner’s office vs. a high priced legal squadron from a multi-billion dollar insurance company is not a fair fight.
3. Your last paragraph is the most telling, to me. Your comment is not about how consumers have _done_, but how they _feel_. Finance is not about feelings, much though financial companies spend millions on conveying that warm and fuzzy feeling in their commercials. Finance is about numbers. My numbers show that I made money in my stocks from 2007 until today. I kept my money in low cost Vanguard funds, kept investing (new money and re-invested dividends), and re-balanced when needed. This is the same thing that insurance company fund managers do, but without the wood-paneled offices, fancy suits, bonuses, and 6%+ costs. Here is my challenge, if Michael Zhuang is willing to act as referee. I am willing to send my spreadsheets of my investments from 2007 through 2011 to Mr. Zhaung. You send the same data for your high priced annuity, or better yet, to avoid cherry-picking, send the whole range of annuity data for your whole company’s portfolio that you sell. (I assume you’re a salesman from the way you write.) We’ll see who did better, you with your high costs and “guarantees”, or me.
December 23, 2011 at 10:14 pm
Jerry,
Thanks for the answer. I am more than willing to be the referee.
Michael
April 1, 2012 at 11:40 pm
Michael,
Thank you for the post. I just went through my elderly father’s variable annuity and other investments his financial advisor bought him and am disgusted. People have no idea how bad they are being taken advantage of by their trusted advisor. I now have to take the time to break down the fees and search through the prospectus to show him why it is a terrible investment. Once more his advisor had spoken with him recently because the end of the surrender period is approaching and he told him it’s a 4 year investment and he needs to get into something else. Are their laws that could hold him accountable for clearly breaking his fiduciary duty? Conveniently in the fine print his annuity started the day before the surrender fees were lowered.
Tim
April 1, 2012 at 11:50 pm
Jerry,
I appreciate your post as well! It has been tough for me to convince my loved ones to fire their sketchy financial advisors and purchase low cost index funds or Berkshire Hathaway. I just sent out 10 copies of John Bogle’s book “The little book of common sense investing” in hopes that it is short and straight forward enough to have an impact. I’m not a very good salesman (even though I’m not selling anything and just trying to get them to realize the better way to invest passively)…if only I could recruit one of these annuity sales people to actually do good and give sound financial advise (something tells me that won’t happen). Anyway any advice on straightforward material I can direct my family and friends to would be much appreciated.
Tim
April 2, 2012 at 3:27 pm
Tim,
Thanks for your comments.
You are doing all the right things. The financial industry is spending billions of dollar brainwashing people. It takes a lot of work to undo the damage.
I have an email newsletter that I send out monthly. A little education every month may lead to changed behavior. You may want to sign up for those people you care about.
http://visitor.constantcontact.com/email.jsp?m=1101911263066&p=oi
April 2, 2012 at 6:37 pm
Hello Tim,
I can recommend the investing books by Allan Roth, a CFP who also has a financial blog on CBS MoneyWatch. I don’t remember if he directly addresses variable annuities in his books, but I know he does talk about them in his blogs. He says in most cases that variable annuities are over-sold because they’re mainly good for the salesman. The sales people really sell hope and fear, not financial products, which is why their approach is so strong, so light on facts and firm numbers, and so hard to shake off. regards,
Jerry
May 14, 2012 at 2:27 pm
Anon,
This is my opinion, not a personalized advice. I trust Vanguard, they will not have layers upon layers of hidden fees. But still you have to consider carefully whether VA is right for you: with VA, you save on capital gain taxes and will end up paying income taxes which are at a higher rate.
Michael
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April 1, 2011 at 6:09 pm
I agree with your analysis on the teaser rates that are floating around the annuity markets. One interesting thing you should be aware of is that many of the variable annuity contracts funded prior to the market correction now have death benefits (equal to cost basis) in excess of the current account values, which insurance companies never anticipated they would have to pay out on…