What Covers the Cost of a Variable Annuity’s Death Benefit?
Understand the costs covering your variable annuity's death benefit and how they affect your long-term investment value.
A variable annuity functions as a contract between an individual and an insurance company, combining aspects of both insurance and investment. Individuals typically invest a sum of money, often for retirement savings, with the expectation of receiving periodic payments in the future. A key feature within this financial product is the death benefit, designed to provide a payout to designated beneficiaries upon the death of the annuitant.
Understanding the Variable Annuity Death Benefit
The variable annuity death benefit protects beneficiaries by ensuring a minimum payout, even if the annuity’s investment sub-accounts decline in value. Upon the annuitant’s death, beneficiaries generally receive either the current account value or a guaranteed minimum amount, whichever is greater. This helps mitigate the risk of investment losses impacting the inheritance.
Common structures for these death benefits vary. A basic death benefit might guarantee a return of the original principal, minus any withdrawals. Other options include a “stepped-up” death benefit, which periodically locks in the highest account value achieved on specific dates, such as contract anniversaries. This allows potential investment gains to be secured as the new guaranteed minimum, even if the market later declines.
Direct Costs and Their Funding Mechanisms
The cost of a variable annuity’s death benefit is primarily covered through specific fees and charges embedded within the annuity contract. These are internal deductions from the annuity’s account value, not separate bills.
A significant portion of the death benefit cost is within Mortality & Expense (M&E) fees. These recurring charges compensate the insurance company for the mortality risk it assumes and for administrative costs. M&E fees are typically calculated as an annual percentage of the annuity’s account value, often ranging from 0.50% to 2.0% per year.
For enhanced or optional death benefits, such as those that guarantee a step-up in value, additional rider charges are often assessed. These riders provide greater protection or potential for increased payouts to beneficiaries, coming with their own annual fees. These charges are also typically expressed as an annual percentage of the account value.
These costs, including M&E fees and rider charges, are typically deducted directly from the annuity’s account value. Deductions often occur on a daily or quarterly basis, integrating the fees into the annuity’s performance calculation.
How Costs Affect Your Annuity’s Value
The ongoing fees and charges associated with a variable annuity’s death benefit directly influence its overall performance and accumulated value. These deductions reduce the money available for investment growth, diminishing net returns on the annuity’s underlying investment options.
While the death benefit provides protection against market downturns, it comes at the expense of potential investment accumulation. Higher death benefit guarantees, particularly those offered through optional riders, generally correspond to higher costs. These increased expenses can further erode the annuity’s growth potential over time. Therefore, a trade-off exists between the level of guaranteed protection desired and the impact on the annuity’s long-term growth.