The good news is, if there are bad annuities, there are certainly good ones out there.
Today we’re going to go in-depth and discuss what you should look for in a variable annuity.
What is a variable annuity?
Put simply, a variable annuity is an insurance investment. In reality, it’s a contract that you pay for in premiums with considerable investment benefits.
Like other insurance investments, you can add “riders” to your investment. This bumps up the cost but also makes the annuity more valuable. For example, an income rider guarantees an income for life for both the investor and their spouse.
The big draw for a variable annuity, however, is the fact that it is tax-free. But online an IRA, where you are limited to about $7,000 a year, you can store up to $1 million in an annuity.
Is it a good investment?
The big question on everyone’s mind: Is a variable annuity worth it?
The truth? Yes and no.
There are three issues most people run into when it comes to purchasing a variable annuity:
- Hidden Fees
- Limited or poor investment options
- The surrender fee
For example, most commission-based variable annuities come equipped with an average 3-4% overall fee. And if you’re promised 5%-7% returns, that cost takes a good chunk out of your earnings.
But let’s focus a minute on your fees. You can find them in the prospectus. And there are quite a few. Some examples of common fees are:
- Administrative fee - Usually .30%
- Investment Expense Ratio - Usually up to 2.5%
- Mortality and Expense Risk Charges (M&E) - Up to 2%
- Commission Fee - Up to 10%
- Surrender Fee - Up to 10%, paid upon prematurely selling your annuity
Additional riders can also tack on more to your expenses. Which doesn’t leave much room for you to make money.
In addition, these products usually contain investment options linked to mutual funds owned by the same company that sold you the annuity. Now those may be good investments. But normally you’ve got a lot of bad choices, with low return rates.
For example, an annuity might generate $10,000 in income, but the insurance is $8,000 in fees. You only make $2,000. This sounds good at first. But what if you lowered those fees? You could be making $5,000 or even $8,000.
Finally, the big kicker is the surrender fee.
Let’s say you decide to buy a variable annuity worth $1 million. When that happens, the insurance company pays the broker their commission, which is 5%. That means the insurance company pays the broker $50,000 on the front end.
But what happens if you decide you want to get rid of the annuity after six months? Then the surrender fee kicks in. This is essentially a penalty is that covers the insurance company’s payment to the broker of $50,000. So if you want to get out of the annuity within the year, the surrender charge would be that $50,000.
That means many investors end up stuck with variable annuities, and may even hold on to them long after the surrender period. Even if they aren’t making as much as they could be.
That said, there are ways that you can optimize your variable annuity.
Turning a liability into an asset
If your surrender period is over, you have the option to take control of your annuity and increase your earnings.
To turn your annuity into a real asset, you’ll want to shift the management from the brokerage to a Registered Investment Advisor (RIA). When you do this, two things happen:
- Your fees drop considerably - potentially to 1%
- You get access to a wider range of quality investment options.
For example, you may end up with an RIA that only charges 1% for all investments. This drops your fees by 3% points right off the bat if you had an annuity with a 4% annual fee. But RIA firms also have access to multimillion-dollar, high-ranked funds that brokers don’t have access to. So it’s possible that your returns will also increase.
In other words, shifting your variable to an RIA firm is a great way to reduce fees, boost revenue, and flip that costly annuity into a valuable investment vehicle.
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