Annuities: Getting Rid of the Middle Man
The Net is making annuities more affordable

Despite their growing popularity with investors, variable annuities have long been maligned for their hefty costs. These insurance products geared to retirement investing allow your money to grow tax-deferred in mutual fund-like ''sub-accounts.'' But they often carry steep fees to pay for sales commissions and their special insurance features. Fidelity, Schwab, Vanguard, and TIAA-CREF have addressed the cost problem by selling their own inexpensive contracts directly to the public through their regular distribution channels.

But now, new online annuity brokers are going a step further. Through their Web sites, they're offering a number of different companies' products with lower or even no commissions. They're also giving investors a lot of leeway to move money between annuities, much like they can do with mutual funds.

One of these sites,, offers six no-load variable annuities that are normally sold through brokers or financial planners at a commission. The Web marketer also lets you switch between annuity contracts without penalty, eliminating the often onerous surrender charges. The reason for these charges is that the annuity sellers have to advance a commission to a salesperson, a cost they plan to recover over time. If you cash out of the annuities before the fee is recovered, you have to cough up the surrender charge, which can be as high as 9% of the annuity's value. The highest fees are in the first year and usually decline a percentage point a year.

PRINCIPAL GUARANTEE. By axing the salesman, AnnuityScout reaps savings it can then pass to investors. ''Our cost of distribution is about a tenth of face-to-face broker distribution,'' says Gregory Yost, AnnuityScout's chief executive. As a result, AnnuityScout can offer American Skandia's Advisors Choice 2000 annuity with a mortality and expense (M&E) charge of only 0.5% (table). That's less than half the industry average of 1.13%. Of course, these fees don't include investment management costs, which are roughly akin to what you would pay for a similar mutual fund.

The M&E charge covers the annuity's distribution costs and insurance death benefit (which guarantees the principal back if the annuity holder should die with less money in the account than originally invested). But most of the M&E typically goes toward commissions. To see how investors benefit, a similar product sold by brokers--American Skandia Imperium--has a 1.25% M&E fee and a surrender charge that starts at 7.5% and decreases over time.

Advisors Choice 2000 appeals to investors who like choice. It features 46 investment options from 26 fund companies. These sub-accounts include clones of the hottest growth funds: ProFunds UltraOTC, Marsico Capital Growth, INVESCO Dynamics, and Alger Growth. There's also a fund that mimics Pimco Total Return Fund, whose portfolio manager, William Gross, is one of the best in bonds anywhere. Advisors Choice 2000 also sports six sector funds, including INVESCO Telecommunications, which has a whopping 59.2% three-year annualized return. (That return is for the actual mutual fund, which is the model for this annuity sub-account. The sub-account itself is new.)

Such aggressive investments are ideally suited for an annuity because they have high turnover, meaning they generate a lot of short-term capital gains. In a regular taxable fund, such an investment could generate a big tax bill every year. In an annuity, all taxes are deferred until you start withdrawing the money.

For the more conservative value investors, AnnuityScout has another contract--Advisor's Edge. It boasts 28 options, including noted value funds managed by Dimensional Fund Advisors, Dreyfus, and Strong, and an M&E charge of just 0.5%. AnnuityScout's other contracts, although commission-free, have much higher expenses.

AnnuityScout hopes to add a no-load version of a commission-paying contract at the rate of one per month, says President Tina Baughman. But the online broker is getting resistance. ''We're begging insurers to give us the product no-load,'' Baughman says. ''But some are reluctant because they have a lot of agents out there who need commissions to pay their bills.''

AnnuityScout was not the first Web innovator in annuities. markets four low-cost variable annuity contracts, three of which have no surrender charges. The contracts aren't clones of those sold by brokers, but have been custom-designed for the site. AnnuityNet allows Web transfers between sub-accounts and the ability to see statements online. The drawback, though, is that its annuities have fewer investment choices. Its GE Savvy Investor has the most sub-accounts, 25, and a moderate M&E fee of 0.75%. Its eAnnuity contract has 19 choices, but a 3% surrender charge.

CHEAP ALTERNATIVES. If cost is more important than choice, check out giants TIAA-CREF and Vanguard Group. TIAA-CREF's Personal Annuity Select is the least expensive, with total expenses (including M&E) ranging from 0.37% to 0.59% for its six sub-accounts. That compares with an industry average of 2.13%. Vanguard's Variable Annuity Plan is also dirt cheap, with 13 investment options and a 0.27% M&E charge. Funds for both annuities are limited to house brands, and many are index funds or quasi-index products.

Such cheap alternatives may push many insurers into direct distribution. No-load annuities are just 3% of the $1 trillion annuity market now, but their influence is growing. ''We're about to cross $1 billion in assets,'' says Barry Streit, Charles Schwab's vice-president of annuity sales. ''That's double where we were last year with virtually no marketing.'' Much new money comes from investors transferring assets from broker-sold annuities. Such transfers account for some 75% of Schwab's business, 35% of TIAA-CREF's, and more than 50% of Vanguard's.

Schwab, which pioneered the mutual-fund supermarket, is not yet taking that path with variable annuities. It only offers one product, Schwab Select Annuity, which has 29 investment options and a 0.85% M&E. But Streit says he would like to make more available down the road.

Mutual fund giant Fidelity Investments is also a power in annuities. Its Fidelity Retirement Reserves is the most popular direct-sold annuity, with $16 billion in assets. It has 28 sub-accounts and a 0.75% M&E. Its non-Fidelity funds are run by top managers at PBHG, Warburg Pincus, Morgan Stanley Dean Witter, and Strong. Fidelity has no plans to broaden its product line.

Even with lower costs, variable annuities aren't for everyone. Don't buy them if you may need your money early. As with 401(k)s and individual retirement accounts, you'll pay a 10% penalty for withdrawals before age 59 1/2. Also, you're better off maximizing contributions to 401(k)s and IRAs first. They're cheaper forms of tax-deferred investing, since they don't carry M&E charges. But if you've exploited all the other tax-deferred retirement options, lower-cost annuities make sense.


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Annuities: Getting Rid of the Middle Man

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