Why Advisors Will Likely Clamor For Cheaper Annuities Soon
November 2, 2015 by John F. Wasik
If the Department of Labor’s Fiduciary proposal goes into effect, advisors may find themselves taking a closer look at low-cost annuities.
The push by regulators for greater advisor accountability and more prudent investment recommendations will be a boon for products that offer client-friendly features and lower costs. This may encourage more annuity providers to compete on price.
Advisors have slowly embraced low-cost annuities in recent years, and their sales have jumped from $3.6 billion in 2010 to nearly $6 billion in 2014, according to the Insured Retirement Institute, the trade association that represents annuity sellers. The IRI defines low-cost as variable products that have no sales commissions or surrender charges and keep their annual expenses under 1%.
Bells and whistles like income guarantees, living benefits and payouts indexed to stock market returns have increased these products’ popularity among some advisors and their clients. Although relatively unheard of 15 years ago, there are now more than 220 living benefit products in the variable annuity space, Morningstar analyst John McCarthy says.
DRILLING DOWN ON VARIABLES
Variable annuities are complex beasts. Since they are amalgams of mutual funds with myriad benefits, they have several layers of fees.
The mortality, expense and administrative charge pays for the cost of the insurance, administration and commissions; this is expressed as a percentage of the amount in the account. According to AnnuityFYI, an online annuity service, the average industrywide fee is 1.4%. Charges below 1% put the product in a low-cost category. So-called no-load annuities don’t pay commissions.
Insurance companies don’t want customers withdrawing too much of their money too quickly, so they impose surrender fees if funds are withdrawn before a certain time period (seven years on average). Low-cost products don’t have surrender fees, and there are also short surrender products that are subject to withdrawal surcharges for only a few years.
Variables also charge subaccount fees, known as expense ratios in the mutual fund world. These are what fund companies charge for managing funds within the annuity, and they vary widely from more than 1% to under 0.3%.
There are also miscellaneous fees such as maintenance charges, which are usually flat fees. The industry average is $35, which may be waived for accounts over $50,000.
SPECIAL RIDERS
As with most insurance products, clients pay extra for special riders such as lifetime income and enhanced death benefits. Those options tend to add 0.4% to 1.1% to annual expenses. Here are two examples of popular riders and their average cost:
Guaranteed Minimum Income Benefits: For clients who want to lock in a payment, these riders guarantee a minimum monthly benefit regardless of the underlying performance of the product. But they typically don’t kick in until after the 10th year of the contract and they apply only when the client annuitizes.
But they also add from 1% to 1.15% to the annual expense.
Lifetime Income Benefits: A form of longevity insurance, this is another failsafe that guarantees a payment even if the account balance goes to zero. Say your client purchased a $100,000 annuity with this rider guaranteeing a 5% return. If the balance went to nothing, there would still be a $5,000 annual withdrawal.
