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Understanding how an annuity agent gets paid.:
One of the most frequently used negative claims against annuities is that they pay too high of a commission to the selling agent, and the fees are too high. This argument is often used as a blanket statement against all annuities, without further explanation or comparison to alternative investment vehicles.
This article will attempt to shed an unbiased light on how fixed annuity commissions are paid to agents, and how they 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 and annuity carriers.
The commissions for annuities can range anywhere from 2% to 8%. The general rule of thumb when it comes to annuity commissions is that the more complicated the annuity, the higher the commission will be for the selling agent. 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 index annuity, the commission will be higher (5%-8%). The reason being, the MYGA is more of a commodity driven product that is very easy to explain and understand, while an index annuity can have many moving part with 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 3.30% (May 2020 Rates - Check Current Rates), no more and no less once you lock in the rate. However, if you purchase index 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), plus other features such as lifetime income riders, nursing home benefits and enhanced death benefits to name a few. Despite the fact that the commission is higher for an index annuity, the overall value can also be much higher for the policy owner, given the right circumstance.
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 (or higher if the annuity gave a bonus). However, in order to offset the cost of the commissions and to safeguard against early termination of the policy before those costs can be recouped, the insurance company will impose a surrender change on the annuity.
A surrender change is a penalty applied to the annuity value. This penalty decreases over time until the contract length is fulfilled. Keep in mind, as long as you follow the stated rules of the annuity contract, and allow your money to grow for the entirety of the contract, you will never be subjected to a surrender change.
Annuities are generally commission based products as explained above, while other investment vehicles such as mutual funds are fee based. A fee is a percentage taken from an account value each year, which is used for operating expenses, including 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. While annuities typically use an upfront commission system, there can be fees associated to an annuity for additional benefits, such as a guaranteed roll-up rate for an income rider.
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