Variable annuities aren’t simple and they aren’t cheap. I was once again reminded of this after analyzing a couple of policies in recent weeks.

Before I get too deep into variable annuities, I cannot stress enough how much a true financial plan helps to minimize the motivation to purchase a financial product, especially products designed to feed off a sense of insecurity. A deep concern of outliving one’s assets is often the key driver of most annuity purchases. No financial professional should ever dismiss this fear, out of hand. An objective adviser should instead work to understand and address the fear.

So how exactly do variable annuities work? At its simplest level, your money is invested in a basket of mutual funds. Your money then moves in lock-step with the financial markets. That certainly explains the “variable” part.

Now, without yet considering the added bells and whistles that often ride on top of variable annuities, this simple part of your policy represents your ‘true’ account value. The cost of these mutual funds runs about 1 percent per year.

However, in addition to these mutual fund costs, the insurance company also imposes some other nebulous-sounding charges and fees. These charges and fees typically add up to another 1.4 percent per year.

The high cost of about 2.5 percent per year in fees naturally hobbles the growth potential of your simple mutual fund portfolio. With a balanced portfolio of mutual funds, your variable annuity might be destined to make about 2 percent per year. You might fairly ask if this doesn’t just sound like a very expensive mutual fund program. I’d agree.

To combat this reality, insurance companies dangle enticing add-ons, called living benefit riders that work to address the dual pain points of investment volatility and the fear of running out of money in your retirement.

When you add a living benefit rider to the picture, your policy actually has a second “shadow” account value that is wholly-unrelated to your “true” account value. It is typical for your shadow account value to offer a guaranteed annual return of around 6 percent, promised for about a decade. After that, the shadow account stops growing and can only be accessed if you agree to receive a lifetime of monthly payments. These riders cost yet another 1 percent per year.

Without the help of an extended bull market, it should be clear that the “true” account value — after all those fees — simply cannot compete with the “shadow” account.

So what do you get when you make the rational choice of accepting the lifetime of monthly payments? For the next 12 to 15 years, the insurance company sends you back your own money plus the little bit of growth you got to keep. Only after you’ve been made whole does the insurance company finally start to send you their money.

As you can tell, my quick answer to the variable annuity question is “Just Say No.” As you can no doubt imagine, figuring out what to do, if anything, after you’ve already purchased a variable annuity is more complicated.

Jason P. Tank, CFA is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at and at

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