Check the charges before investing

During the past month, I have been describing some of the basics about variable annuities and how they work. This week, I'll describe the various charges you will pay when you invest in a variable annuity.

Be sure you understand all of the charges before you invest because they will reduce the value of your account and the return on your investment. Often, they will include the following:

Surrender Charges

If you withdraw money from a variable annuity within a certain period after a purchase payment (typically within six to eight years, but sometimes as long as 10 years), the insurance company usually will assess a "surrender" charge, which is a type of sales charge. This charge is used to pay your financial professional a commission for selling the variable annuity to you.

Generally, the surrender charge is a percentage of the amount withdrawn and declines gradually over a period of several years, known as the "surrender period." For example, a 7 percent charge might apply in the first year after a purchase payment, 6 percent in the second year, 5 percent in the third year and so on until the eighth year, when the surrender charge no longer applies. Often, contracts will allow you to withdraw part of your account value each year — 10 percent or 15 percent of your account value, for example — without paying a surrender charge.

Example: You purchase a variable annuity contract with a $10,000 purchase payment. The contract has a schedule of surrender charges, beginning with a 7 percent charge in the first year and declining by 1 percent each year. In addition, you are allowed to withdraw 10 percent of your contract value each year free of surrender charges. In the first year, you decide to withdraw $5,000, or one-half of your contract value of $10,000 (assuming that your contract value has not increased or decreased because of investment performance). In this case, you could withdraw $1,000 (10 percent of the contract value) free of surrender charges, but you would pay a surrender charge of 7 percent, or $280, on the other $4,000 withdrawn.

Mortality and Expense Risk Charge

This charge is equal to a certain percentage of your account value, typically in the range of 1.25 percent per year. This charge compensates the insurance company for insurance risks it assumes under the annuity contract. Profit from the mortality and expense risk charge is sometimes used to pay the insurer's costs for selling the variable annuity, such as a commission paid to your financial professional for selling the variable annuity to you.

Example: Your variable annuity has a mortality and expense risk charge at an annual rate of 1.25 percent of the account value. Your average account value during the year is $20,000, so you will pay $250 in mortality and expense risk charges that year.

Administrative Fees

The insurer may deduct charges to cover recordkeeping and other administrative expenses. This may be charged as a flat account maintenance fee (perhaps $25 or $30 per year) or as a percentage of your account value (typically about 0.15 percent per year).

Example: Your variable annuity charges administrative fees at an annual rate of 0.15 percent of account value. Your average account value during the year is $50,000. You will pay $75 in administrative fees.

Underlying Fund Expenses

You also will indirectly pay the fees and expenses imposed by the mutual funds that are the underlying investment options for your variable annuity.

Fees and Charges for Other Features

Special features offered by some variable annuities — such as a stepped-up death benefit, a guaranteed minimum income benefit or long-term care insurance — often carry additional fees and charges.

Other charges — such as initial sales loads or fees for transferring part of your account from one investment option to another — may also apply. Ask your financial professional to explain all charges that may apply. You can also find a description of the charges in the prospectus for any variable annuity that you are considering.

Coming Next Week

The "bonus credit" features of variable annuities.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at [email protected]


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