How Are Variable Annuity Sales Charges Structured?

B-Share Variable Annuities

Most variable annuity contracts are B-share products. They are offered with no initial sales charge, but cancellation of the contract during its early years may trigger a withdrawal charge known as a surrender charge. These charges typically range from 5 percent to 7 percent of premium in the first policy year, and subsequently decline to zero, generally after five to seven years (known as the surrender charge period). Some annuity contracts impose surrender charges only during the initial surrender charge period that begins after the contract is purchased, while others associate a new surrender charge period with each subsequent premium payment.

Surrender charges underscore the long-term nature of the annuity product. As long as contract owners remain committed to accumulating money for retirement through their variable annuity, they generally will not incur these charges. In addition to surrender charges, B-share contracts have annual M&E and administration fees.

A number of insurers have begun to offer other types of charge structures to meet different investor needs. The following are the most common.

A-Share Variable Annuities

A-share variable annuities have up-front sales charges instead of surrender charges. Sales charges are calculated as a percentage of each premium payment. These offer breakpoint pricing, which means up-front sales charges decrease depending on the cumulative amount of purchase payments that have been made. In addition, assets that a contract owner has in other products in the company’s product line may be recognized in the cumulative payment amount used to determine the breakpoint pricing. A-share contracts often have lower ongoing M&E annual fees than annuities with surrender charges

C-Share or No-Surrender-Charge Variable Annuities

C-share, or no-surrender-charge variable annuities, offer full liquidity to owners at any time, without any up-front or surrender charges (although tax penalties may apply to withdrawals before age 59½). There are, however, ongoing M&E and administrative fees.

I-share or Fee-Based Variable Annuities

I-share, or fee-based variable annuities, are intended for investors who favor paying one fee to have their investment portfolio managed by a registered investment advisor or fee-only advisor, for example, a wrap-fee advisory program. Typically, the sale of an I-share does not result in a sales commission for an advisor from the issuing insurance company. However, the advisor assesses fees for services, including the I-share contract, which are agreed upon by the client. Consequently, M&E annual fees are generally less than other share-classes due to the absence of commissions. I-shares generally have no surrender charges and may provide optional living benefit guarantees for an additional fee.

L-Share Variable Annuities

L-share variable annuities have no up-front sales charges. They typically have relatively short surrender charge periods, such as three or four years, but may have higher ongoing M&E and administrative charges than other share classes. It is becoming more common for L-shares to be structured as a B-share with an optional “buy down,” which reduces the duration of surrender charges for an additional fee. This “liquidity rider” expires when the shortened surrender charge period is over, as does its fee.

O-share Variable Annuities

O-shares are intended to merge the advantageous M&E and surrender charges of A-share and B-share variable annuities, respectively. Unlike A-shares, O-shares do not impose up-front sales charges, while, typically, possessing surrender charge periods akin to B-shares. Instead, M&E charges are assessed against both the account value and the premium, with the premium-based charges progressively declining throughout the surrender period, and ending after the surrender period. These features result in expenses similar to an A-share once the contract is free of surrender charges. The design of O-shares encourages investors to think of variable annuities as a long-term investment by rewarding longer holding periods with lower fees.

X-Share (Bonus) Variable Annuities

X-Share variable annuity contracts credit an additional amount or bonus to the contract value, which is calculated as a percentage of purchase payments added to the contract at or subsequent to contract issue. Bonus amounts generally range from 1 percent to 6 percent. For example, with a 3 percent bonus feature, a contract owner paying $10,000 in premiums would have $300 credited immediately to the balance. This category does not include contracts that credit additional amounts to the contract value after a designated period, sometimes referred to as “persistency bonuses.” Variable annuities with bonus credits may have higher ongoing expense charges and longer surrender periods than variable annuities without bonus credits. Some contracts allow the insurer to re-capture all or part of the bonus if the contract is surrendered within the first few years. Bonus contracts are difficult for companies to offer in a low interest rate environment, and there are far fewer available than there once were.

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