Variable Annuities: A Closer Look


At some point, you have probably heard a broker or an insurance agent ask that question to you:  “How would you like to invest in the stock market, protect yourself from a market downturn, have a guaranteed annual return, and provide income for the rest of your life?  Given the recent economic crisis and volatile stock market, it might have sounded compelling.

These brokers and agents are referring to variable annuities. While these investments can seem attractive, it is important to understand how they work. Most importantly, before you make a commitment to a variable annuity, you need to be aware of the fees that are associated with the guarantees.

First, insurers charge several administrative fees which may be 1% to 2%.

Second, they pay sizeable commissions to agents who sell variable annuities. A 5% commission is not unusual. In addition, agents typically receive an additional 0.5% annual commission.

Next, insurers place your money in “sub accounts,” where it is invested in mutual funds. These mutual funds each typically have a 1% management fee.

Then, in order for the annuity to provide you with a guaranteed income stream each year until you die, no matter how poorly the market performs, you would need to purchase a “living benefit rider.” This rider typically costs about 1.15%.

Totaling all of these fees, a variable annuity with a living benefit rider will take around 3.5% off of the top of your investment return each year.

 Other Limitations of Variable Annuities

In addition to the administrative and investment fees, you may be assessed surrender charges if you “cash in” your annuity too soon. The insurance company does not want investors to use their variable annuities as short-term investments, so it attaches surrender charges.

It is not uncommon for surrender charge to be 7% if you take your money out the first year, 6% if you take your money out the second year, 5% the third year, and so on, until you have held your annuity for the required time period.

It gets worse. By locking-in your money, you have given up precious flexibility in your investments. This might put additional constraints on you because you will need to keep other funds liquid for emergencies—funds that you otherwise would be able to invest.

Finally, one of the strong selling points of variable annuities in the past was that the investment gains would grow tax-free (but would be taxed as income when received). However, with the capital gains rate at 15% for most taxpayers, even this benefit is not significant.


While finding security in your investments has become a top priority in recent years, it is important to know what you are giving up—and at what cost—before incorporating a variable annuity in your retirement plan. Brokers and insurance agents can make variable annuities sound like can’t-miss propositions. But the truth is that they come with high costs (commissions, fees and surrender charges) and limit your financial flexibility.

If you are concerned about creating a secure income stream for your retirement, there are options besides a variable annuity. Contact 410.461.3900 or tismart@bwfa.com