by Steve Goodman
CPA, MBA – President & Chief Executive Officer
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For how long are surrender charges assessed and what are the surrender charges each year?
Annuities have different surrender charges and surrender charge periods. Make sure you understand this and compare surrender charges and surrender charge periods between different annuities.
Is there an amount that can be taken out of an annuity each year without a surrender charge? If so, what is this amount, and does it carry over to the next year?
Most annuities allow you to withdraw 10% each year without any surrender charges or market value adjustments.
Why are insurance carrier ratings from S&P, Moody’s, Duff & Phelps, and Weiss important?
It’s critical that you work with a high-quality insurance company. An annuity is a long-term liability on the part of the insurer, so you want to be sure the company will be around for the long haul. Therefore, make sure you compare the ratings of various companies to determine their quality.
Does it matter if an insurance agent is a captive agent of a particular insurance company?
If an agent is a captive agent of a particular insurance company — like New York Life, Mass Mutual, Guardian, Penn Mutual or Northwestern Mutual, for example — he or she is likely to focus on selling that company’s annuities. Instead, you should make sure you get quotes from different companies. Request a comparison of five of the top-rated insurance companies from your agent.
How should I compare insurance companies?
Request a comparison of the top five rated companies and make sure that all the questions noted here have been sufficiently answered.
Should I ask about reduced commission products?
Yes, ask the insurance company if there are there any reduced commission products available.
Do I need to receive a prospectus when I purchase an annuity? What is the breakdown of all fees in the contract for each rider you select? What are the past 10 years performance of each sub account?
It is imperative that you receive a prospectus when purchasing a variable annuity. Read it carefully and understand all the fees associated with riders, as well as the performance of sub-accounts.
What investment restrictions exist based on the riders I select?
If you are choosing certain riders that protect you if the market goes down, the insurance company will usually force you to allocate a sizeable portion of your premiums to a fixed-income account. When you combine the costs of the riders with the reduced investment returns due to the sizeable fixed-income component, the growth of your account balance will be substantially reduced.
Should I purchase a GMBR (guaranteed minimum benefit rider) or a GMWBR (guaranteed minimum withdrawal benefit rider)? How do they work?
These are additional riders you can purchase with an annuity. Both riders must be added at the time of annuity purchase and are only available on deferred annuities. The accumulation period for the riders may be several years, typically ten or more. The annuitant must agree to annuitize the payout to benefit from these riders.
When one purchase either rider, the annuity issuer will establish two accounts for the annuity. The first is the accumulation account that is established for all annuity accounts. It identifies the current cash value of the account. The rider requires that the annuity issuer establish a parallel account based on the rider’s benefit. The second account is a virtual account. The annuitant cannot touch this account at any time during the accumulation phase.
Once the distribution phase commences, the annuitant will benefit from the higher of the accumulation account or the parallel rider account.
The GMBR guarantees that an annuity will achieve a minimum annual return over the accumulation phase. Say an annuitant funds a deferred variable annuity with $100,000 in Year 1. The GMBR may guarantee a 4% annual compound interest on the $100,000. If the accumulation account has shown a compound annual return of 3.2% by Year 10, the GMBR guarantees that the cash amount in the annuity will be increased to reflect the 4% rate. If the accumulation account reflected a 4.2% compounded annual rate, the GMBR will provide no benefit.
The GMWBR operates in a similar fashion as the GMBR during the accumulation phases. As the annuity transition from accumulation to distribution, it guarantees that the annuitant can withdraw at least the amount of capital that was originally invested in the variable annuity. Returning to our $100,000 example, the GMWBR guarantees that the sum of the payouts will at least equal $100,000. Note that an annuitant may not accelerate the payouts, nor may he/she take the payments in a lump sum. The payouts must be annuitized.
In short, both guarantees offer the annuitant a floor investment return in the event of poor market conditions or poor cash allocations during the accumulation period.
Be sure your insurance agent/broker provides a clear explanation of the difference between these two riders before purchasing.
What are the tax consequences when withdrawals are made from an annuity?
You should consult with a tax advisor about questions related to the tax treatment of annuities.
How much will the annuity contract cost annually?
The richer the guarantees in an annuity contract, the more expensive it will be. Deferred annuity contracts typically charge an administrative fee of between 0.10%-0.25%.
In addition, there may be mortality and expense fees of between 1.0%-1.5%, depending on how much the insurance company will pay at death. A simple death benefit option will feature lower mortality and expense charges of between 0.5%-1.0%. There will also be fees if you choose any additional optional benefits (like guaranteed minimum returns or sustainable lifetime withdrawals) that will increase the cost of an annuity contract. There are three main types of additional optional benefit features:
- Income features — These guarantee an uninterrupted cash flow stream regardless of market fluctuations. Fees vary between insurance companies but income features generally cost between 0.5%-1.5%.
- Death-benefit features — The most common is a return of the initial premium paid. Other death benefit features provide different kinds of increased death benefits. These features usually aren’t necessary if you’re using an annuity as an investment tool.
- Access features — These include being able to withdraw funds without early withdrawal penalties should you become terminally ill or disabled. Sometimes access features are standard in annuity contracts and sometimes they cost more.
Variable contracts will also charge direct or indirect asset management fees. Total costs for a deferred variable annuity will usually range between 1.75% annually for a no-frills contract to over 3.25% annually for a contract that guarantees income and death benefits. It’s important to understand all fees and compare fees between insurance companies.
If I invest $100,000 today, what will the annuity contract value be in one year?
This will depend on whether the market rises, falls, or remains flat. Calculating net returns on annuity contracts can be complicated — you must consider all fees and the formulas applied to calculate the total return. Don’t buy an annuity contract if you can’t calculate net returns.
What are guaranteed retirement income benefits?
This is a guarantee that you can withdraw a minimum percentage from your annuity — usually between 4%-7% of the initial contract value — regardless of how your investments perform. This can provide you with additional financial security during retirement at a typical cost of about 1%.
What is the income guarantee?
This will provide you with income protection for the rest of your life. For example, you could invest $100,000 in equities and receive a guarantee of 5% a year for life-based on this amount. So even if the equity markets fall and you or your spouse lives to age 100, one of you would continue to receive 5% a year for life.
Conversely, if the equity markets rise — for example, your $100,000 grows to $150,000 — your guarantee could be reset so that you receive 5% of $150,000. If the markets subsequently fall and your account value drops down to $90,000, you’d still earn 5% a year for life based on the high value of $150,000.
What are the typical variable annuity expenses?
Variable Annuity Expense Description Hypothetical Annual Cost
Administrative Fees 0.18%
Optional Guaranteed Lifetime Withdrawal Benefit Rider 1.02%
Optional Guaranteed Minimum Death Benefit Rider 0.60%
Mortality and Expense Risk 1.17%
Fund Expense for Underlying Funds in Variable Annuity 0.93%
Total Cost 3.90%
What are the limited investment options?
When you buy a variable annuity, you usually don’t have full control over how to allocate your investments when utilizing living benefit riders. Some insurers now limit the growth potential of living benefit riders by reducing equity exposure — this prevents the income benefit from rising too rapidly and may reduce your guaranteed benefit.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.