The Truth About Annuity Commissions
Understanding the payment process for an annuity agent
One of the most frequently used negative claims against annuities is that annuity commissions paid to the selling agent are too high. Some annuity critics argue that this makes annuities an inappropriate investment without further explanation or comparison to alternative investment vehicles.
This article will provide an unbiased explanation of annuity commission. It will also explain how commissions effect the policy owner. There are exceptions to every rule, however the examples in this article will cover the practices of the vast majority of annuities.
How Much Commission Do Annuities Pay?
The commissions for annuities can range anywhere from 2% to 8%. The general rule for annuity commissions is that the more complicated the annuity, the higher the commissions. If the annuity is a straight forward multi-year guaranteed annuity (myga) that gives the policy owner a fixed interest rate for a set amount of years, the commission will be on the lower end of the spectrum (2%-3% on average). If the annuity is a more complicated and longer term product, such as an indexed annuity, the commission will be higher (5%-8%). The reason is that a MYGA is a commodity-driven product that is very easy to explain and understand. An indexed annuity has many moving parts and a longer surrender period, making it a more complicated sale.
Does that mean a person should only buy the simpler products with lower commissions? No, not necessarily. The type of annuity to buy is completely situational to the buyers needs. If you were to purchase a straight 10 year fixed annuity today, your interest rate would be around 5.00%. However, if you purchase an indexed annuity, you have the potential for a much higher rate of return because of the fact that the interest rate is tied to an index (S&P, Nasdaq, etc). They also offer other features such as lifetime income riders, nursing home benefits and enhanced death benefits. Despite the fact that the commission is higher for an indexed annuity, the overall value can be higher for the policy owner.
Who Pays the Commission to an Annuity Agent?
The simple answer to who pays the commission to an annuity agent is that the insurance company pays it. As the buyer of an annuity, you would never pay anything directly to your financial planner. Nor would the commission come off the value of your account. If you invest $100,000 into an annuity with a 5% commission, your starting value would still be $100,000. However, that policy owner will be subject to a surrender charge for early termination of the policy. The insurance company uses this to offset the cost of commissions and to recoup their losses.
A surrender charge deducts a fee from the funds in the account. This fee will decrease over time until it reaches zero at the end of the contract term. Keep in mind that you never pay this fee as long as you follow the stated rules of the annuity contract and allow your money to grow for its entirety.
Annuity Commissions vs. Fees
Annuities are generally commission based products as explained above, while other investment vehicles such as mutual funds are fee based. A fee based product deduct a percentage of the account value each year rather than using an upfront commission system. This fee is used for operating expenses, which includes compensation to the financial planner.
The trade off to an annual fee is there is no surrender charge, however you essentially pay out of pocket each year.
If you invest in a mutual fund with a 1.5% fee, by the 5th year the amount has already reached 9%, assuming no growth, and even higher when calculating any positive gains. It should be noted that there may be fees associated with an annuity for additional benefits, such as a guaranteed roll-up rate for an income rider.