We have seen variable annuities offered with a great sales pitch: continued growth opportunities through market exposure coupled with some form of protection via an optional rider.  This sales presentation may satisfy our emotional needs to protect our Nest Egg, especially in light of the recent economic events now referred to as the Great Recession. But just as in buying a home, we believe it is essential to get beyond the curb appeal and inspect the property in detail before investing your resources.
Beware of offers that seem too good to be true, such as guaranteed income or a guaranteed minimum withdrawal on your money by investing in a variable annuity. 
Investment salespeople are making big promises (and bigger commissions) in an attempt to get you to retire so they can invest your pension and 401(k) monies. There is no such thing as a free lunch and annuities are no exception. In many cases, the “guaranteed” annual returns are not gains on your investment principal. Rather, they are increases on the variable annuity’s income base, as discussed later in this article. Costs of variable annuities may run as high as 3-4% annually, and if you want to completely withdrawal from the plan, there may be hefty penalties for several years.
Commissions and Withdrawal Charges
An annuity salesperson can make a commission anywhere in the range of 4-7% on the sale of a variable annuity product.  For example, if a representative sold you a variable annuity and you invested $300,000 into the policy, the agent could potentially make a gross profit of around $21,000 for selling it to you.
In order to cover the costs for paying the sales agents these commissions, annuity companies have withdrawal charges tied to the products that can range anywhere from 4-9 years, or more. These withdrawal charges are often referred to as CDSCs (contingent deferred sales charges). They reduce the risk associated with policy owner turnover. If an investor doesn’t stay in the policy long enough, they can’t make enough profit to cover the commission payouts and still come out in the green, hence the withdrawal charges.
Contract Value vs. Benefit Base
Your Contract Value is represented by your premium payments which are invested in the sub-accounts, less any withdrawals. In a lot of variable annuities, the Contract Value may not be guaranteed, or free from risk. It can fluctuate in value over time per the underlying investment mix. If you close the policy out or move your money to a separate investment account you get the contract value, which very well may be lower than what you started with depending on the investment performance.
In some annuities, the Benefit Base is the “guaranteed” part of the annuity policy. In many cases, the benefit base may only be accessed if you convert the investment into a monthly annuity. Many times, investors confuse the contract value and the benefit base. It’s important to know what is what and how those guarantees actually play out in real life.
Within a variable annuity, the investment options are technically known as sub-accounts. They behave like mutual funds, but are under the umbrella of the annuity. The fees you incur from the sub-accounts will vary depending on the sub-accounts selected within your annuity. As is the case with other investment vehicles, conservative, indexed, or passive investment vehicles will generally carry lower fee-structures in comparison to equity oriented, tactical, or actively managed options. The fees associated with these sub-accounts typically range from about 0.5%-2%.  These sub-account expenses are on top of the annual operational and rider fees.
Investors often get into an annuity without fully understanding the product and its features. Variable annuities are very complex investment products and it is essential that investors understand all the facts before purchasing these policies. Be sure to read the prospectus and do your homework. The question that must be asked if you are considering purchasing a variable annuity is, “Is this the BEST tool I can use to achieve my desired financial goals?”
- IBID, https://www.sec.gov/investor/alerts/ib_var_annuities.pdf,
- https://www.jackson.com/static/pdf/jmv9476.pdf, page 9
This information is provided for general information purposes only and is not intended to provide specific investment advice. The information in the articles should not be relied on for tax reporting, accounting, or valuation purposes. Past performance is not a guarantee of future performance. It is not possible to invest directly in an index.
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