How Are Expenses, Fees, & Charges Assessed in Immediate Annuities?
You can turn your savings into a pension-style income stream by purchasing an immediate income annuity. Issued by life insurance companies, immediate annuities are actually insurance policies rather than investment instruments. Although immediate annuity contracts do not detail fees and charges, insurance companies could not remain solvent if these products were not profitable. Charges are worked into the contract, and some are more apparent than others.
You buy an immediate annuity with a lump sum of cash. Your insurer immediately multiplies your purchase premium by a fixed interest rate and converts the resulting sum of cash into an income stream. Depending on the terms of the contract, the income may last for a number of years or for life. Insurance companies sell large numbers of immediate annuities to investors and use actuarial tables to calculate the average life expectancy of the purchasers. Typically, the benefits stop when you die.
You do not pay a direct fee when you buy an immediate annuity, but charges are worked into your interest rate. Rates on annuities are set so that the insurer will make money if the average annuitant lives no longer than expected. Since you receive your lump sum back in small increments, you basically get back nothing but your own premiums for several years before you really begin to make any money. In the meantime, your insurer invests your premiums in low-risk instruments. Your insurer attempts to make sure its own rate of return on your premium is higher than the interest you earn on the contract. You make money and your insurer loses money if you live longer than expected.
The impact that unseen fees have on your immediate annuity becomes apparent if you ask your insurer for a number of different contract options. From an insurance company's perspective, joint contracts are twice as risky as single-life policies because either owner could live longer than expected. Consequently, interest rates on joint contracts tend to be lower than on single-life policies. Likewise, rates on long-term contracts are higher than on short-term contracts because insurers have more time to make money on your investment.
You can further safeguard your money by purchasing annuity riders. A rider is basically an insurance stipulation that provides you with a tangible benefit if a certain event occurs. You can buy a death benefit so your beneficiaries receive a payout if you die sooner than expected. You can also buy inflation protection riders so your income level increases in line with inflation. Such riders appear on your annuity statement as fees. Typically, a rider is assessed as a percentage of your monthly income. On your statement you see your gross income and your net income after fees and taxes have been deducted.