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.