A $500,000 annuity growing at 7.17% can double in value in only 10 years. That’s the good news. The bad news: it’s likely the expenses in these older variable annuities have doubled as well.
People purchase annuities usually for their tax-deferral feature. The growth isn’t taxed until the money is taken out. Makes sense. Variable annuities have sub-accounts which are similar to mutual funds and it’s the insurance wrapper that buys the tax-deferral feature. This wrapper, of course, comes at a cost (what doesn’t?) for mortality and administration expenses.
Many of the annuities that were available years ago – and still today – charge a percentage of account value to cover those costs; but, as the account value increases, so do the expenses. There’s more: these insurance expenses are in addition to the expenses for the underlying investments.
Here’s a hypothetical example: it’s not uncommon for the ‘insurance wrapper’, especially in older annuities, to come in at around 1.4%. So, the cost of a $500,000 variable annuity at 1.4% would be $7,000. It that annuity doubles to $1 million in value over ten years, the wrapper would cost just over $13,000. Did the annuity’s cost really grow that much?
How much would that wrapper cost over a ten-year period? A little calculation shows that the total cost would come to $97,495 – and that’s if the money grew by 7.17% annually. Obviously, the expenses for a 9% or 10% growth rate would have been much higher.
Nevertheless, paying almost $100,000 in administration for $500,000 worth of growth, even with tax deferral, can look pretty steep.
Those with older variable annuities, especially those with low or no surrender charges may want to review them.
Jim
