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Fixed and Variable Annuity Costs: What You Need to Know

Fixed and Variable Annuity Costs: What You Need to Know

When you think of annuities, you may think of a policy owner that pays an insurance company a premium(s), and in return receives a series of annuitized payments for a defined period of time.  Ultimately, an annuity is a contractual agreement between an insurance company and policy owner.  When both parties enter into the annuity contract, the policy owner transfers certain risk(s) to the insurance company.  Perhaps the policy owner is concerned of outliving their finances (longevity risk) or perhaps the policy owner is concerned about market volatility (investment risk).  Regardless of the reasons the annuity is purchased, the policy owner must compensate the insurance company for the assumption of risk(s).  Unfortunately, understanding annuity costs can be difficult and overwhelming, and requires a thorough review and understanding of the annuity contract.  This article will explore various potential costs associated with fixed and variable annuities.

Before considering annuity costs, it is important to understand the difference between a fixed and variable annuity.

Fixed Annuity

A fixed annuity is often purchased for its predictability and guaranteed stream of income.  The policy owner transfers investment risk to the insurer and premiums are invested into the insurer’s pooled general account.  The insurer uses the funds in the general account in a variety of ways, but a portion of the funds will be invested (usually into a portfolio of bonds) to cover various claims and liabilities (i.e. annuitized payments, annuity withdrawals, etc.).  

Variable Annuity

A variable annuity can be more complex than a fixed annuity.  A variable annuity is often purchased for its potential to offer higher returns during the annuity’s accumulation phase.  Unlike fixed annuities, the policy owner assumes the investment risk and the premiums are held separately from the insurer’s general account.  Funds are invested into various subaccounts (similar to mutual funds) that may fluctuate with market performance.


Since fixed and variable annuities differ in structure, it may not be surprising to learn that they differ in cost as well. Below is a brief summary of common annuity costs sorted by annuity type.

Fixed and Variable Annuities

  • Sales Charge: A sales charge may be assessed for either fixed annuities or variable annuities. The charges may be assessed in different ways and will depend on the pricing structure of each annuity product.  A sales charge may be in the form of a front-end sales charge.  This is a charge that is assessed up front on the initial contribution.  Alternatively, an annuity sales charge may be charged over a period of time.  Finally, an annuity may charge a contingent deferred sales charge which may be assessed upon surrender, liquidation or withdrawal of more than the policy’s free withdrawal amount.  Surrender charges generally decrease over the life of an annuity and may completely disappear after a certain period of time.
  • Riders (Optional Benefits): Fixed and variable annuities may offer additional benefits in the form of riders.  For example, an annuity contract may offer a guaranteed minimum income benefit, a guaranteed minimum accumulation benefit, or even a guaranteed lifetime withdrawal benefit.  Regardless of what the rider is, it is important to note that riders typically come with an increased cost.

Variable Annuities

  • Insurance Charges: An insurance company may assess additional charges on an annuity to compensate for the transfer of risk to the insurance company.  For example, the insurance company may have a mortality and expense (M&E) charge to help compensate for the risk of underestimating longevity.  In addition to the M&E charge, the insurance company may also assess administrative charges and distribution charges as well.  These charges are subtracted from the annuity account balance on an ongoing basis.
  • Subaccount Expense Ratios: Subaccounts, similar in theory to mutual funds, carry their own individual expense ratios and must be considered when assessing an annuities total cost. 

Fixed Annuities

  • Interest Rate Spread: Insurance companies do not assess charges on fixed annuities the same way that they assess charges on variable annuities.  Rather, insurance companies assess an interest rate spread.  To understand an interest rate spread, it is important to recall that when premiums are paid for a fixed annuity, the funds are invested into an insurer’s general account.  As mentioned previously, the insurer’s general account invests in a variety of bond investments in an effort to cover the insurer’s liabilities.  The insurer holds back a portion of the interest earned on the various investments (known as the interest rate spread) to compensate itself for expenses or to generate a profit.  The insurance company then pays the remaining interest to the fixed annuity contracts.
  • Market Value Adjustment: As mentioned previously, the insurer assumes the investment risk of its general account, which is generally invested in a variety of bonds.  Because of this, the insurer is subject to interest rate risk, just like an investor would have been had they been invested in bonds.  A market value adjustment may be assessed by the insurance company if the current interest rate differs from a set benchmark rate.  If interest rates increase over and above the benchmark rate, the surrender value of an annuity contract may be decreased.  On the contrary, if interest rates fall below the benchmark rate, the surrender value may be increased and benefits the policy owner.  A market value adjustment is a way for the insurance company to protect itself in the event of rising interest rates (which have a negative impact on bond prices).  The adjustment is usually only assessed on withdrawals in excess of the penalty-free amount.

All investment and insurance products carry costs.  The key to making an informed decision is to understand the costs and weigh them against the potential benefits.  Annuities are no exception; however, they do tend to be more complex in structure and accompanied by lengthy contracts and prospectuses.  This article explored some of the standard costs associated with annuities, but it is not an exhaustive list of all costs.  It is important to speak with your advisor that is knowledgeable about annuities to fully understand the specific costs associated with the annuity in question so that you too can make an informed decision.

Contact SVA Plumb Financial to learn more about your options.

© 2018

All information herein has been prepared solely for informational purposes only and opinions are subject to change. Past performance is not indicative of future results and all investments involve the risk of loss of principle. For information on how these general principles apply to your situation, consult an investment professional.


Article Topic Specialist: Jay Neary

Jay is a Financial Consultant with SVA Wealth Management, LLC.

Jay focuses on financial planning and helping clients realize their financial goals. In an increasingly complex financial world, simplifying personal finances is one of Jay’s passions. He is a part of a diverse team of wealth management professionals who help individuals and families accumulate, preserve and transfer their wealth.

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