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Are Fee-Based Annuities Right for You?

In response to the Department of Labor’s fiduciary rule, which requires financial advisors to offer retirement advice that is only in their clients’ best interests, the annuity industry has introduced a new generation of product. Several big time insurers, including Lincoln Financial Group, Pacific Life and Great American Life Insurance, have launched new “fee based” variable and fixed-indexed annuities for use in brokerage accounts. With this new type of annuity, investors pay an annual asset-based fee, rather than a hefty upfront commission, which was often blamed for the negative reputation given to their older cousins. But according to a recent Kiplinger article, the trend isn’t a clear win for investors.

The fee-based annuity market has exploded this year and with good reason. When fees are charged separately, as opposed to commissions embedded into the annuity contract, it’s easier for investors to understand how much they’re paying for services versus the investment. And with the concern over an adviser looking to cash in a big commission at any cost eliminated, fee-based annuities help ensure that a client’s best interests are the top priority.

But there is one rather obvious drawback with fee-based annuities. If you’re planning to hold the contract for the rest of your life, and there isn’t much for your adviser to do after recommending an appropriate product in the beginning, you might find it hard to justify paying an annual asset-based fee. Before signing on the dotted line of your new annuity contract, it’s always recommended to weigh the costs and determine if your product of choice is best for your unique situation.

In many cases, fee-based annuities are significantly cheaper than commission-based options. For example, variable annuities, which are tax-deferred products that allow you to invest in mutual-fund-like accounts. The annual fee for a typical commission-based variable annuity is about 3%. Most fee-based variable annuities have annual fees of 1-2%, plus the adviser’s fee.

On one hand, traditional variable annuities require active management, and therefore justifies paying an annual asset-based fee to an adviser. On the other hand, fee-based fixed-indexed annuities don’t require much ongoing active management, which critics argue means they don’t make as much sense for investors. . The downside is limited, but gains are too. According to Stan “The Annuity Man” Haithcock, “there’s no rationale to charge an ongoing asset-based fee in these annuities.”

But don’t count out the fee-based products. By eliminating the commission, insurers can improve the guaranteed minimum interest rate and the cap on gains in fee-based fixed-indexed annuities, claims Will Fuller, president of annuity solutions at Lincoln Financial Group. He added that depending on the level of the adviser’s fee, a client could get a higher rate than if he bought the commission-based product.

When considering a fee-based annuity, make sure that you add the advisory fee to the product cost for an “apples-to-apples comparison” against commission-based annuities, said Mark Cortazzo, a former financial planner. For example, a fee-based variable annuity with annual fees of 1.8% might look like a bargain compared with a commission-based variable annuity charging 3% a year. However, when you add the 1% annual fee that’s typical with a fee-based account, your total cost is now 2.8%, nearly the same as the commission-based option.

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