Variable Insurance and Variable Annuity Charges
You will pay several charges when you invest in variable insurance contracts, including variable annuities. Be sure you understand all the charges before you invest. These charges will reduce the value of your account and the return on your investment. The following will focus on charges and expenses associated with variable annuities; however, many of the same expenses that apply to variable annuities are also applicable to variable life insurance contracts. Typically, the costs associated with the insurance component of the contracts will be more significant with respect to variable life insurance because of the more substantial tax-free death benefits. As with all products, refer to the prospectus or other offering documents for specific details.
Typical charges and expenses for variable annuities will include the following:
Surrender charges – If you withdraw money from a variable product within a certain period after a purchase payment (typically within six to eight years, but sometimes as long as ten 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 Generally, the surrender charge is a percentage of the amount withdrawn, and declines gradually over a period of several years, known as the “surrender period.”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% charge might apply in the first year after a purchase payment, 6% in the second year, 5% 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% or 15% 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% charge in the first year, and declining by 1% each year. In addition, you are allowed to withdraw 10% 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% of contract value) free of surrender charges, but you would pay a surrender charge of 7%, or $280, on the other $4,000 withdrawn.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% 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 of 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% of 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 record-keeping 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 in the range of 0.15% per year).
Example: Your variable annuity charges administrative fees at an annual rate of 0.15% of account value. Your average account value during the year is $50,000. You will pay $75 in administrative fees.
Underlying Fund Expenses – You will also indirectly pay the fees and expenses imposed by the mutual funds that are the underlying investment options for your variable annuity. Such fees include, for example, 12b-1 fees (see discussion in mutual fund section), certain tax charges levied against insurance companies, and similar expenses.
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. You should ask your financial professional to explain to you 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.
Annuities are long-term insurance products designed for retirement purposes. Before buying any variable annuity, request a prospectus from your financial professional, and read it carefully. The prospectus contains important information about the annuity contract, including fees, investment options, death benefits, and annuity payout options. Annuity payouts are subject to the claims paying ability and financial strength of the issuing insurance company. An investment in an annuity involves market risk and possible loss of principal. If you are considering purchasing an annuity as an IRA or other tax-qualified plan, you should consider benefits other than tax deferral since those plans already provide tax-deferred status.
Tax-Free “1035” Exchanges of Variable Products:
Section 1035 of the U.S. Tax Code allows you to exchange certain insurance products for others, such as an existing variable annuity contract for another variable annuity contract, or a variable life insurance contract to another variable life or variable annuity contract, without paying any tax on the income and investment gains in your current variable annuity account. These tax-free exchanges, known as 1035 exchanges, can be useful if another variable product has features that you prefer, such as a larger death benefit, different annuity payout options, or a wider selection of investment choices.
You may, however, be required to pay surrender charges on the old contract if you are still in the surrender charge period. In addition, a new surrender charge period generally begins when you exchange into the new contract. This means that, for a significant number of years (as many as 10 years), you typically will have to pay a surrender charge (which can be substantial) if you withdraw funds from the new contract. Further, the new contract may have higher annual fees and charges than the old contract, which will reduce your returns. You should take all these factors into consideration in determining whether an exchange makes sense for you.