What it means
Variable annuities are sold in different share classes, and each class balances fees against flexibility. The B share has a long surrender period, often seven years or more, with lower ongoing costs.
The L share has a shorter surrender schedule, typically around three or four years, but charges more each year. The higher cost usually comes from the insurance and administration charges built into the contract.
In practice, this means the investor pays for the right to get out sooner without a penalty. Whether that is good value depends on how likely the investor is to need the money early.
The surrender charge is normally a percentage of the amount withdrawn above any free withdrawal allowance, and it falls each year until it reaches zero. For instance, a schedule might start at a higher percentage in year one and step down annually.
After the surrender period ends, the investor can withdraw without a charge, but the higher annual fees may continue. That last point is important.
Because the fees may stay at the higher level after the surrender period ends, an investor who stays in the contract for many years can pay more overall than they would have with a cheaper class. Comparing the total cost over the investor's expected holding period is the right test.
Annuities are complex products, and the details differ between insurers and countries. Anyone considering one should read the contract, compare costs across share classes and consider whether the product suits their tax position and time horizon.
Costs in annuities come in layers, and it is easy to focus on only one of them. As well as the insurance charge, there may be fund management fees, rider charges for optional guarantees and administration fees.
Adding all of these together gives the real annual cost, which is the figure to compare between share classes and between providers.
In practice
Real-world examples.
Example
A 58-year-old business owner expects to need access to funds in about four years to help buy a new premises. She chooses an L share class so that the surrender period ends before she needs the money.
Example
A financial adviser compares B and L share classes for a client who is unsure about future cash needs. The adviser calculates the extra annual fee and explains that it is the price of flexibility.
Example
A couple with a $200,000 inheritance want a tax-deferred investment but may need cash for a house deposit. They accept a higher annual charge in return for a four-year surrender schedule.
Formula
Calculation
Surrender charge = amount withdrawn x surrender charge rate for that year
Extra annual cost of an L share = contract value x (L share fee % - B share fee %)
Worked example: an investor puts $100,000 into an L share contract and withdraws $50,000 in year two, when the surrender charge is 6%. The L share costs 0.30% a year more than the B share.
Step 1: Surrender charge = 50,000 x 0.06 = $3,000.
Step 2: Net amount received = 50,000 - 3,000 = $47,000.
Step 3: Extra annual fee on a $100,000 value = 100,000 x 0.003 = $300 per year.
Over ten years, assuming a steady balance, the extra fee would add up to $3,000 (300 x 10 = 3,000). The investor must weigh that against the flexibility of the shorter lock-in.Case study
Seen in the real world.
Oakfield Wealth Partners is a fictional advisory firm. A client, Marta, wanted to invest $120,000 in a variable annuity but planned to withdraw about a third within three years to renovate a property.
The adviser showed her two options. The B share class had lower fees but a seven-year surrender schedule, while the L share class had a four-year schedule and fees about 0.30% a year higher.
In this illustrative story, Marta chose the L share because the penalty she might pay on the B share could be larger than the extra fee. She also set a reminder to review the contract at the end of the surrender period, to see whether switching to a cheaper option made sense.
Watch out
Common mistakes.
- Choosing a share class on the surrender period alone, without comparing the annual fees over the full holding period.
- Assuming the higher fees stop when the surrender period ends, when they often continue for the life of the contract.
- Believing an annuity can be cashed out freely, when withdrawals may trigger surrender charges and tax consequences.
Questions
People also ask.
What is a surrender period?
It is the time after purchase during which withdrawing more than the free allowance triggers a penalty.
Who might prefer an L share?
Someone who expects to need access to the money sooner and is willing to pay higher yearly fees for that flexibility.
Can I switch to a cheaper share class later?
Sometimes, but it depends on the insurer and the contract terms, so ask before you buy.
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