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On the accompanying chart entitled “The Impact Of Costs On Variable Annuities”, we have pulled together information from both Morningstar, Inc. and on fee ranges not only the variable annuities themselves, but those of the benefit riders (riders provide extra features or offer extra guarantees) which have been commonly offered as add-ons to variable annuity contracts over the past 20 years.  As the reader will see, the fees can potentially be enormous in the aggregate.  Given that the U.S. stock market as measured by the S&P 500 based upon current long-term valuations imply a return of approximately 2.0% over the next decade, it would appear that most investment approaches in the form of subaccounts offered by these contracts that merely match the return of the S&P 500 (before their underlying expenses) will be either substantially reduced or wiped out altogether after the variable annuity contract fees and add-on rider expenses are subtracted from the returns.  Furthermore, be on the lookout for caps on returns (Ex. Maximum gain of 10.0%) and/or sharing of gains with the insurance company itself (gain sharing of 50.0% is not unusual).  If there are losses on the underlying investments, breakeven may be a long way away.

While many of the guarantees offered via variable annuities can enhance one’s situation, the cost of purchasing too many of the riders and/or in conjunction with a traditional Mortality and Expense (M&E) ratio [one whose base M&E fee exceeds 50 basis points (50 basis points is ½ of one percent).  Most M&E fees exceed 1.25%.] will likely subject the investor to mediocre returns even when double-digit raw returns occur. In order to take advantage of some of the guarantees, the investor must hold on to the annuity for at least ten years and more likely longer.  Also, they generally must annuitize, making the guarantee less attractive in many cases.


One additional recent development over the last couple of years is that it has been reported not only in numerous articles as well as insurance company notifications and press releases is that despite the high fees charged by the insurance companies, many of these riders are causing losses to the insurance companies on the contracts.  This is, and probably will continue, to cause insurance companies to put restrictions on existing contracts, especially from an investment standpoint.  Furthermore, many insurance companies that issued these contracts previously have stopped issuing new ones.


In the end, it appears the result that occurs from purchasing such “expensive” annuities with more than one or two of these additional riders is guaranteed mediocrity of one’s investment returns from such a product. 


What’s an investor to do?  Choices are extremely limited, especially since there is a 10.0% income tax penalty for those under age 59½.  Also, most annuities are sold with significant back-end penalties (surrender charges) for the first seven to ten years irrespective of one’s age that do eventually graduate downward.  Perhaps the best option is to switch to a low load annuity, if the back-end surrender charges are not too high on the existing contract (3.0% or preferably less).  Unfortunately, there are only a handful of these low load type of contracts available. However, this type of switching analysis usually requires the expertise of a Fee-Only advisor, especially if certain guarantee riders have been purchased.  If so, it may be best to wait it out—although that could be as long as a decade or more, if the annuity was purchased in the last few years.


By Louis P. Stanasolovich, CFP®, CCO, CEO and President of Legend Financial Advisors, Inc.®and EmergingWealth Investment Management, Inc.®





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