The real cost of annuities: an overview of what you pay for what you get

Annuities are a great way to invest, protect yourself against savings in retirement, and even protect a spouse or dependent from the financial consequences of your death. But, as with all financial instruments, annuities come with associated costs. Depending on the characteristics of the contract, the cost structure of an annuity can sometimes seem extremely complex, making it difficult to know whether it is a good investment or not.

How much do annuities really cost? What factors come into play when insurance companies calculate premiums? These are important questions we should all ask ourselves before making a disbursement over $ 100,000, and I will answer them in this article.

Factors that affect the cost of an annuity

Just like deciding which mutual fund to choose, comparing insurance policies or even choosing a credit card, for that matter, choosing an annuity comes down to comparing its cost with its benefits. In this sense, annuities can have different fees and commissions associated depending on a series of factors. The ones that matter most are:

  • Age.
  • Genre.
  • General state of health.
  • Type of annuity contract.
  • Contractual amendments.

Age, gender and general health affect annuities differently from life insurance. In general, the longer your life expectancy, the more you usually have to pay for an annuity (whereas the reverse is true for some insurance products). Consequently, women generally pay more in fees than men, except in certain cases where the annuity is linked to a pension. Fund 401 (k), which has gender equality requirements.

On some types of annuities, younger people also pay more because of a longer life expectancy. On the flip side, having bad medical conditions that increase your risk of life-threatening illnesses and reduce your life expectancy can lower the fees you have to pay on some annuities and even increase the monthly payment you might receive.

The other two factors, ie the type of annuity and the addition of contract riders, deserve separate sections.

Cost of the different types of annuities

The type of annuity is one of the most influential factors influencing the cost of entering into these contracts:

The costs of variable annuities vs fixed annuities

Fixed annuities have virtually no costs. Depending on the insurance company and the person who sold you the annuity, they may receive a sales commission that you, as the annuitant, ultimately pay. However, other than that, there are usually no other costs involved, as long as you go for a simple contract without adding any provisions or endorsements, but I’ll get to that later.

In the case of variable annuities, these are subject to several upfront fees and other charges. Variable annuities invest your funds in an investment portfolio so that your account is exposed to the market, the value of which potentially increases over time. While your money is not invested in bitcoin or other high risk investments, investment portfolios will generally include assets such as stocks, bonds, and indices.

In these cases, there will be an administrative fee to cover the bookkeeping and other administrative costs associated with opening and maintaining the investment sub-account. You will also have to pay fees and other expenses related to the underlying fund where your premium is invested, which can reach values ​​of 1% of the amount invested each year or more.

Payout annuity costs vs deferred annuity costs

Payout annuities are those that are automatically converted into annuities when the contract is signed. In other words, they have no accumulation period during which your investment will be grow tax-deferred.

In the case of a standard immediate annuity contract, with the account being immediately annuitant, you start receiving monthly payments according to the terms of the contract (fixed or variable for example) right away for the rest of your life. In these cases, the insurance company estimates how long you are likely to live based on your particular characteristics when purchasing the annuity. Once they get a reliable estimate, they calculate how much you have to pay each month so that the full value of your initial investment i.e. the one-time premium is completely used up by the time they make the last payment. foreseen.

This begs the question: what if you outlive your estimated life expectancy? If this happens, you will continue to receive your payments regardless. Insurance companies cover these apparent additional costs by consolidating all the funds available for annuity annuities into one account. This allows them to pay for people who outlive their lifespan with money from people who died earlier than expected, thus spreading the risk of losing money.

In the case of deferred annuities, things are a little different. You invest a lump sum today, let it grow over time, and start collecting income if you decide to turn it into an annuity on a specific date in the future. In these cases, there will be a redemption charge of up to 10% if you withdraw some or all of your money from your pension earlier, although the percentage usually decreases the longer you wait.

Costs of adding amendments or contract provisions

Endorsements are simply additions or provisions that you add to a standard annuity contract to customize it to better meet your needs. For example, you usually lose the right to the premium you paid when you convert your annuity to an annuity to start receiving monthly payments. In other words, you can’t change your mind and tell the insurance company that you want your money back. You also lose the right to pass on unused benefits to your heirs if you die before you have used up the value of your initial investment.

One way around this problem is to add provisions to the contract that allow you to make withdrawals from your account without actually converting it to an annuity. The insurance company will take the capital withdrawals from your account. Thus, when you use up this amount, your account will be considered as an annuitant and you will continue to receive your monthly pension until your death, but you have nothing left to send. or withdraw.

So that insurance companies can afford to make these payments, they cover the risk by charging a fee if you want to add this rider.

Riders can be one-time or recurring, and they mainly come in the form of income protection benefits (like the one pictured above), death benefits, and disability benefits.

Fees for Guaranteed Death Benefit Riders, Guaranteed Income Riders or Guaranteed Limits on Administrative Fee Riders can be up to 1.2% each. This implies that the more riders you add to a basic annuity contract, the more complex and costly it becomes.

The bottom line

Annuities are a form of investment that provides guaranteed retirement income, whether fixed or variable. In order to make an informed decision when purchasing any of these investment products, it is important to understand the costs associated with it. Things like age, gender, general health, type of contract, endorsements or terms can all have an impact on the benefits you might get and their costs.

While some annuities can get very expensive due to multiple fees and commissions, others are much more affordable. As a general rule, the simpler the contract and the fewer endorsements you request, the less expensive the annuity.

After reviewing the above, you can decide what is most important to you about planning for retirement. Suppose you want to maximize the dollar value of your lifetime monthly income and you don’t want to protect your principal. In this case, you will be able to avoid most of the fees and other costs associated with annuities.

On the flip side, if you are looking for income protection, principal protection, and even long term care protection for a relaxed and easy going retirement, know that it will come at a considerable cost. Ultimately, the choice is yours.