The shift toward fee-based annuities continues to gain traction as insurance companies adapt to regulatory changes, particularly after the introduction of the Department of Labor’s fiduciary rule. Major firms have been expanding their fee-based variable and index annuity offerings. These products aim to better align with the fiduciary rule by prioritizing clients’ best interests, reducing potential conflicts of interest associated with commission-based sales.
Fee-based annuities typically involve charging a flat annual fee rather than earning commissions, making costs more transparent. However, while these products are often seen as a way to comply with fiduciary standards, they’re not always the most cost-effective option for every client. For example, commission-based annuities might still be cheaper for clients planning to hold the annuity long-term, as the total fees could be lower than ongoing advisory fees associated with fee-based products.
Commissionable annuities are a type of annuity product where financial advisors receive a commission from the insurance company for selling the annuity to a client. These commissions are typically embedded in the product’s cost structure, often resulting in higher fees for the client over the life of the annuity. For example, a commission-based variable annuity may carry annual expenses around 3%, including charges for mortality, administration, and guarantees. Despite the higher costs, some advisors and clients prefer commissionable annuities because they eliminate the need for upfront fees, making them more attractive for long-term investments where advisory services may be minimal after the initial sale.
However, commissionable annuities have faced criticism for potentially incentivizing advisors to prioritize products that offer higher commissions over those that might better suit a client’s needs. This concern has led to increased scrutiny, especially under regulations like the Department of Labor’s fiduciary rule, which requires advisors to act in the best interest of their clients. While commissionable annuities can still be appropriate for certain clients—especially those who prefer not to pay ongoing advisory fees—it’s crucial that both clients and advisors carefully evaluate the total cost and suitability of these products before committing
There are many factors to consider such as the specific annuity’s features, the client’s investment horizon, and the cost-benefit trade-off between upfront commissions versus ongoing fees. In an effort to help clients decide which product is better for them, we recommend considering the following.
- How does a product’s contract costs, such as its mortality and expense charges, compare to the advisory fee? If the contract is 1% cheaper and the advisor charges a 1% fee, a policyholder would probably prefer a fee-based option, which would offer a lower, if any, surrender charge (money paid if withdrawals are made before a certain time).
- Is there a difference in the costs of the underlying annuity subaccounts? If the answer is yes, does that affect the answer to the first question? Some insurers are bringing out fee-based variable annuities with lower cost sub-accounts or without the 12b-1 fees for marketing and distribution which other products include.
- How likely is it that the policyholder may need to access some of their principal to handle unplanned life costs? If this is a likely scenario, a fee-based product will be more attractive because of the lower surrender charges.
- Is a living benefit, which guarantees certain benefits and terms in exchange for a fee, being added? If so, a commissionable product might be more cost effective if a client is expected to hold the product for a long period of time. Consider doing a cost-benefit analysis comparing the size of the advisory fee to the cost of the contract.
- Consider this, the average commissionable variable annuity has an annual cost of 1.3% while fee-based variable annuities usually cost 0.3% to 0.6%. If the advisory fee is 1% and a fee-based annuity costs 0.3%, the product choice may not matter. But if fees or expenses are higher, the commissionable product could be the better option.
Bottom line, it’s worth taking the time to explore all options, ensure complete understanding and make a decision based on a well-thought out and communicated process. Not all products are created equal and no two clients are alike. As cliche as it may seem, it doesn’t have to be any more complicated than that.
