- Know your needs.
- Understand the product.
- Focus on value, including the price.
- Get familiar with fee types.
In the past, misconceptions about annuity fees may have kept some people from buying these investment products. However, many annuities have come a long way in terms of lowering costs and clearing up confusion among shoppers.
Before making an annuity purchase, shoppers could benefit from knowing the rules of the road. By asking the right questions up front, and by having a better understanding of the features you might be paying for, you should be able to gain a much clearer sense of whether an annuity might fit your needs.
Start by following some basic guidelines for evaluating the potential costs of annuities. Then, dig a little deeper into the details of specific fees and determine whether it’s worth paying for added features that may appeal to you.
Understanding the big picture
Different types of annuities—whether variable or fixed, income or deferred—charge different types of fees (see the chart below). Generally, variable annuities charge explicit fees, while fixed annuities tend to embed their costs in the interest rate or income payout amount. Indexed annuities take a different approach by limiting returns through factors such as participation rates, spreads, and caps. For more information on the different types of annuities, learn more about annuities in general, and compare the types of annuities offered by Fidelity.
From a fee perspective, deferred variable annuities can include insurance charges, investment management fees, surrender charges, and rider charges, yet they tend to have a significant degree of variability. This makes direct price comparisons more difficult. Deferred variable annuities may also have many different optional riders or guaranteed features. These features may include both death benefits and living benefits, which come at an additional cost. If these are of interest to you, take some time to research how each feature works (e.g., whether it applies when you are alive or if you die) and consider its price tag. Then, evaluate whether that rider works for your specific situation when considering a variable annuity. It’s also important to review the prospectus thoroughly.
Fixed deferred annuities pay a guaranteed interest rate for a set period of time. This rate reflects reductions for expenses, risks, and profits. The rate is clearly stated in the contract and is easy to compare with other fixed annuities or similar products. Fixed deferred annuities typically have surrender charges. Sometimes the interest rate is reset, up or down, during the surrender charge period, subject to the insurance company’s rate setting process. To take the guesswork out of what your future guaranteed interest rate might be, look for a product that guarantees its interest rate at least as long as the surrender fees are in place. Also, consider the creditworthiness of the issuing insurance company to help evaluate the best overall value.
Fixed income annuities, where payouts can be deferred or immediate, also have expenses, but they might not be immediately apparent because they are built in to the payout amount offered by the insurance company. The good news is that this characteristic makes it easier to compare prices, as you can focus on comparing the payout rate. When you compare payout rates, be mindful of the creditworthiness of the insurance company. A higher payout rate might sound appealing, but if it’s offered by an insurance company whose financial strength you question, it might not be worth the risk. A common way of researching financial strength is by checking out third-party credit ratings issued by agencies like Standard & Poor’s and A.M. Best. Also, be sure you know which features are included in the payout amount such as a Cost of Living Adjustment, so you can compare apples to apples.
Fees vary among annuities
There are different types of fees that are specific to certain types of annuities. Here are some general guidelines to consider when weighing the costs and potential benefits of annuities.
Know your needs. The fees you pay for annuity features can reduce your overall return, so opt only for those that you need and will use. "For instance, if you want protection from market downturns for your savings or future retirement income while you stay invested in the market for growth, you may want a feature that provides a guarantee*—and some peace of mind—if the cost is fair and reasonable," says Tim Gannon, vice president, product management, at Fidelity Investments Life Insurance Company.
Understand the product. Some annuities can be complex to understand. When you're considering a purchase, it's important to understand how the proposed annuity works, what its benefits may be, and, perhaps most importantly, the role it can help play in your overall financial plan. Be sure to read carefully the marketing materials and prospectus (if applicable). If you don't understand what you’re paying for, make sure you ask questions and receive full disclosure before making a decision.
Focus on value, including the price. It's important to evaluate any annuity's costs versus the guarantees it promises. Not all guarantees are created equal. Some guarantees involve cumbersome restrictions that may diminish their appeal, regardless of the price. Also, keep in mind that when you buy an annuity, part of what you are paying for is the creditworthiness of the insurance company standing behind those guarantees.
Become familiar with fee types
While you don't have to become an expert on all annuity fees, knowing the most common types will help you evaluate products and ask the right questions. Generally, there are 4 types of annuity fees:
Insurance charges. Also known as mortality and expense (M&E) fees and administrative fees, these charges pay for insurance guarantees that are automatically included in the annuity, and the selling and administrative expenses of the contract.
Surrender charges. Most insurance companies limit the amount of penalty-free withdrawals one can take during the initial years of a contract, and place a surrender charge on any withdrawals above that preset limit (typically, to help cover the commissions the company paid). Be careful, as surrender charges can be significant and can be imposed for an extended time period. Be sure to ask for details on any surrender charges to help ensure that you have enough flexibility.
Investment management fees. These are assessed on the investment options within variable annuities, and are similar to management fees on mutual funds. Check the annuity prospectus for any underlying funds to learn how much you might pay for investment management fees.
Rider charges. Riders are optional guarantees available in some annuities. For example, an Annual Increase Rider is an optional feature that increases payments each year by a pre-determined percentage, typically 1% to 5%, to help keep pace with inflation. There is typically an additional cost to purchase a rider in an annuity.
Getting good value
There are a few other important considerations before making an annuity purchase.
Consider the totality of all costs. Tom Ewanich, a Fidelity vice president and actuary, says this advice is important and often overlooked. "Rather than focusing on any single fee component, it's prudent to look at all the associated costs together," he says. "In some instances, one variable annuity may have a lower charge than another similar product but more expensive investment options, making the entire package more costly."
Buy from someone reputable. Whether you're working through an adviser or directly through a distributor, get the facts on the firm's financial strength and business practices. What is the company's rating with third-party ratings agencies? Is it known for fair claims-paying practices? How reliable is its customer service? Dealing with a company that's fair and financially sound may help save you from financial headaches in the long run.
Understand hidden costs. For some annuities, you need to be aware of other ways an annuity design can affect your performance. For example, index annuities may offer upside potential, but can actually cap the benefit of market performance. If an index annuity promises upside based on performance of the stock or bond market, ask whether there are caps on how much your annuity can earn.
Read Viewpoints on Fidelity.com: Indexed annuities: Look before you leap.
Remember, it is important to do your homework and comparison shop when it comes to major purchases. Buying an annuity should be no different. It’s easier to understand what you’re buying if you do your homework.
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Before investing, consider the investment objectives, risks, charges, and expenses of the fund or annuity and its investment options. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
Investing in a variable annuity involves risk of loss - investment returns and contract value are not guaranteed and will fluctuate.
Withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty.
Fidelity insurance products are issued by Fidelity Investments Life Insurance Company (FILI), 100 Salem Street, Smithfield, RI 02917, and, in New York, by Empire Fidelity Investments Life Insurance Company®, New York, N.Y. FILI is licensed in all states except New York. Other insurance products available at Fidelity are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. A contract's financial guarantees are subject to the claims-paying ability of the issuing insurance company.
Fixed annuities available at Fidelity are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. These products are distributed by Fidelity Insurance Agency, Inc., and, for certain products, by Fidelity Brokerage Services, Member NYSE, SIPC. A contract’s financial guarantees are solely the responsibility of and are subject to the claims-paying ability of the issuing insurance company.
Transfers may trigger taxes on long- and short-term capital gains. You should consider the consequences of liquidity on assets in your Fidelity brokerage accounts.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917