Variable Annuity Living Benefit Riders: Unpacking Fee Structure Complexity

Variable annuities are already known for their intricate fee structures, but the addition of living benefit riders significantly compounds this complexity. Understanding how these riders impact costs is crucial for anyone considering these products, especially given their long-term nature.

At their core, variable annuities are contracts offering tax-deferred growth and various payout options. They involve several layers of fees even before considering riders. These typically include mortality and expense (M&E) charges, administrative fees, and subaccount management fees (similar to mutual fund expense ratios). These base fees are designed to cover the insurance company’s costs for providing the annuity contract, including mortality risk, administrative overhead, and the management of the underlying investment options.

Living benefit riders are optional add-ons to variable annuities that provide guarantees related to income or principal protection, regardless of market performance. These riders are attractive because they address a key concern with variable annuities: the risk of market downturns eroding retirement savings and income streams. Common living benefit riders include Guaranteed Minimum Income Benefit (GMIB), Guaranteed Minimum Withdrawal Benefit (GMWB), and Guaranteed Lifetime Withdrawal Benefit (GLWB).

The complication arises because living benefit riders are not free; they come with their own set of fees, layered on top of the existing annuity fees. These rider fees are typically expressed as an annual percentage of either the account value or a separate “benefit base.” The benefit base is often initially equal to the premium paid but can grow over time based on contractual terms, sometimes linked to market performance or a predetermined growth rate. Crucially, the benefit base is not cash value that can be directly withdrawn; it’s a metric used to calculate guaranteed benefits.

Here’s where the complexity truly deepens:

• Layered Fees: You’re not just paying for the annuity’s base fees anymore. You are now paying for the annuity and the rider, meaning multiple percentage-based charges are deducted from your account. This can significantly reduce the overall growth potential compared to a similar investment without these layers.

• Fee Calculation Methods: Rider fees can be calculated in various ways. Some are a fixed percentage of the account value, while others are based on the benefit base. This makes direct fee comparisons across different annuities and riders incredibly difficult. Furthermore, some riders may have fees that adjust over time based on factors like age or market conditions, adding another layer of unpredictability.

• Opacity: The interplay between base annuity fees and rider fees can be opaque. Disclosure documents may list fees separately, but it’s not always immediately clear how these fees interact and what the total cost will be over the long term, especially when considering the impact on net returns. It’s crucial to examine the combined effect of all fees.

• Impact on Investment Strategy: The presence of living benefit riders can sometimes influence the investment options available within the annuity. Insurers may limit investment choices to manage their risk exposure related to the guarantees, potentially restricting access to higher-growth but also higher-volatility options that might otherwise be suitable for a long-term investor.

• Forfeiture and Surrender Charges: Exiting a variable annuity with a living benefit rider often involves surrender charges, especially in the early years. These charges can be substantial and are applied to the account value after all other fees have been deducted, further compounding the cost of accessing your money. Furthermore, certain riders might have specific rules or penalties for withdrawals that exceed the guaranteed amount or are taken at certain times, adding another layer of complexity to accessing your funds.

In essence, living benefit riders transform the fee structure from a relatively straightforward set of charges into a multi-layered, potentially less transparent system. While these riders offer valuable guarantees, investors must meticulously dissect the fee structure to understand the true cost of these protections and ensure they align with their financial goals and risk tolerance. Failing to fully grasp the complexity of these fees can lead to unexpected costs and potentially erode the benefits of both the annuity and the rider itself.