12.8 Variable Annuity Charges

Surrender Charge

-If the investor withdraws money from a variable annuity within a certain period after a purchase payment (typically within six to eight years, but sometimes as long as 10 years), the insurance company usually will assess a type of sales charge known as a "surrender" charge -This charge is used to pay the investment representative's commission for selling the variable annuity. Generally, the surrender charge is a percentage of the amount withdrawn and declines gradually over a period of several years, known as the "surrender period". -For example, a 7% charge might apply in the first year after a purchase payment, 6% in the second year, 5% in the third year, and so on until the eighth year, when the surrender charge no longer applies. Often, contracts will allow the annuitant to withdraw part of the account value each year - 10% or 15% of the account value, for example - without paying a surrender charge.

Tax-Free "1035" Exchanges

-Section 1035 of the U.S. tax code allows the owner of an annuity to exchange an existing variable annuity contract for a new annuity contract without paying any tax on the income and investment gains in the current variable annuity account -The annuitant may, however, be required to pay surrender charges on the old annuity if he or she is still in the surrender charge period -In addition, a new surrender charge period generally begins when the client switches into the new annuity. This means that, for a significant number of years (as many as 10 years), the client typically will have to pay a surrender charge (which can be as high as 9% of purchase payments) if he or she withdraws funds from the new annuity. -Furthermore, the new annuity may have higher annual fees and charges than the old annuity, which will reduce the annuity's returns.

Administrative Fees

The insurer may charge fees to cover record-keeping and other administrative expenses. This may be charged as a flat account maintenance fee (perhaps $25 or $30 per year) or as a percentage of the account value (typically in the range of 0.15% per year).

Underlying Fund Expenses

These are fees and expenses imposed by the separate accounts that are the underlying investment options in the variable annuity.

Mortality and Expense Risk Charge

This charge is equal to a certain percentage of the account value, typically in the range of 1-1.25% per year. This charge compensates the insurance company for insurance risks it assumes under the annuity contract. Profit from the mortality and expense risk charge is sometimes used to pay the insurer's costs of selling the variable annuity, such as a commission paid to the investment representative for selling the variable annuity.