Annuity Fees Explained: Surrender Charges, M&E, and Hidden Costs

Annuities can provide valuable guaranteed income in retirement, but they come with costs that are not always easy to see. Some fees are listed clearly in the contract. Others are built into the interest rate you receive or the cap on your returns. Understanding every layer of annuity fees is essential before you commit your money to a long-term contract.

This guide walks through each type of annuity fee, explains how much you can expect to pay, and gives you the questions to ask before buying. This article is for educational purposes only and does not constitute investment advice. Consult a qualified financial advisor before making decisions about annuities or other financial products.

Surrender Charges: The Cost of Early Access

A surrender charge is a penalty you pay if you withdraw more than the allowed amount from your annuity during the surrender period. This is the most common fee across all annuity types, including fixed, variable, and indexed annuities.

Surrender charges typically start at around seven percent of the withdrawal amount in the first year and decrease by about one percentage point each year. A typical surrender schedule might look like this: 7 percent in year one, 6 percent in year two, 5 percent in year three, 4 percent in year four, 3 percent in year five, 2 percent in year six, 1 percent in year seven, and zero percent from year eight onward. Some contracts have shorter surrender periods of three to five years, while others can stretch to ten years or more.

Most annuities include a free withdrawal provision that allows you to take out up to ten percent of your account value per year without triggering a surrender charge. Amounts above that threshold are subject to the charge. Some contracts also waive surrender charges in specific hardship situations, such as terminal illness, confinement to a nursing home, or disability. Always check what waivers are available in your contract.

The surrender charge exists because the insurance company invests your premium in long-term bonds and other assets. If too many policyholders withdraw early, the company may need to sell those assets at a loss. The surrender charge discourages early withdrawals and compensates the insurer for the disruption. Before buying any annuity, make sure you will not need access to the funds during the surrender period.

Mortality and Expense (M&E) Charges

The mortality and expense charge, commonly abbreviated as M&E, is an annual fee found primarily in variable annuities. It compensates the insurance company for the insurance risks it assumes under the contract, including the risk that annuitants will live longer than expected, and for the company's operating expenses and profit.

The average M&E charge on a variable annuity is approximately 1.25 percent of your account value per year. This fee is deducted from your account automatically, typically on a daily basis. It applies regardless of whether your investments are performing well or poorly. On a $200,000 variable annuity, an M&E charge of 1.25 percent would cost you $2,500 per year.

The M&E charge pays for the basic guarantees built into the annuity contract, such as the guaranteed death benefit (which ensures your beneficiaries receive at least your original investment amount if you die during the accumulation phase) and the option to annuitize the contract into a lifetime income stream. Some critics argue that the M&E charge is disproportionately high relative to the cost of these guarantees, but it remains a standard feature of virtually all variable annuity contracts.

Administrative Fees

Administrative fees cover the insurance company's costs for recordkeeping, mailing statements, customer service, and general contract administration. These fees are most common in variable annuities and are charged in addition to the M&E charge.

Administrative fees are typically charged as either a flat dollar amount, usually $25 to $50 per year, or as a percentage of your account value, often around 0.10 to 0.15 percent per year. Some insurance companies waive the flat administrative fee once your account reaches a certain size, such as $50,000 or $100,000. While administrative fees are small individually, they add to the total cost of owning the annuity.

Underlying Fund Expenses (Variable Annuities Only)

Variable annuities allow you to invest in sub-accounts that function like mutual funds. Each sub-account has its own management fees, called expense ratios, which are charged by the fund managers. These fees range from about 0.5 percent to 2 percent per year depending on the type of fund.

Index fund sub-accounts tend to charge on the lower end, while actively managed stock or bond fund sub-accounts charge more. These fund expenses are separate from the M&E charge and administrative fees. They are deducted directly from the fund's returns before your account is credited, so you may not see them as a separate line item on your statement.

This is an important cost because it stacks on top of the M&E and administrative fees. If your variable annuity charges a 1.25 percent M&E fee plus 0.15 percent in administrative fees plus a 0.80 percent fund expense ratio, your total annual cost before any riders is already 2.20 percent. On a $200,000 account, that amounts to $4,400 per year in fees alone.

Rider Fees: Optional Benefits at an Extra Cost

Riders are optional add-on features that enhance your annuity contract with additional guarantees or benefits. Common riders include guaranteed minimum income benefits (GMIB), guaranteed lifetime withdrawal benefits (GLWB), enhanced death benefits, and long-term care riders. Each rider comes with its own annual fee, typically ranging from 0.25 to 1 percent of your account value per year.

Rider fees can add up quickly. If you add a guaranteed lifetime withdrawal benefit at 0.75 percent per year and an enhanced death benefit at 0.50 percent per year, that is an additional 1.25 percent layered on top of the base contract fees. On a variable annuity that already charges 2 percent or more in base fees, adding riders can push total annual costs above 3 percent.

Riders on indexed annuities work slightly differently. The base indexed annuity contract often has no explicit annual fee, but adding a guaranteed lifetime withdrawal benefit rider will introduce an annual charge, commonly 0.50 to 1 percent of the benefit base. Since indexed annuities otherwise have costs embedded in caps and participation rates, the rider fee can be the only explicit charge you see on your statement.

Before adding any rider, calculate the total annual cost and consider whether you could achieve similar protection through a separate product at a lower cost. A financial advisor can help you evaluate whether riders are worth the expense in your specific situation.

Hidden and Embedded Costs

Not all annuity costs appear as explicit line-item fees. Some costs are embedded in the product structure, making them harder to identify and compare.

• Spread on fixed annuities. The insurance company earns a spread between what its investment portfolio yields and the rate it credits to your annuity. If the company earns 6 percent on its bonds but credits you 4.5 percent, the 1.5 percent spread covers the company's costs and profit. This is not a fee you see, but it is a real cost that reduces what you earn.
• Cap and participation rate limitations on indexed annuities. When an indexed annuity caps your return at 6 percent even though the index gained 15 percent, the difference represents the cost of the product's downside protection and the insurer's margin. The lower the cap and participation rate, the higher the implicit cost to you.
• Sales commissions. The agent or advisor who sells you the annuity earns a commission, often 4 to 8 percent of the premium for fixed and indexed annuities, or 1 to 5 percent for variable annuities. You do not pay this commission directly out of your account, but it is built into the product's fee structure. Higher commissions can mean longer surrender periods or less favorable terms for you.
• Market value adjustment (MVA). Some fixed and indexed annuities include a market value adjustment that can increase or decrease the amount you receive if you surrender the contract early. If interest rates have risen since you bought the annuity, the MVA may reduce your surrender value beyond the stated surrender charge.

Total Cost Analysis: Adding It All Up

To understand the true cost of an annuity, you need to add up every fee layer. Here is what total annual costs typically look like by annuity type.

Fixed annuity (MYGA). No explicit annual fees. Costs are embedded in the interest rate spread. Surrender charges apply during the surrender period. Total visible cost: approximately zero percent per year in explicit fees, but the spread reduces your effective return by an amount that is not disclosed.

Variable annuity without riders. M&E charge: approximately 1.25 percent. Administrative fees: approximately 0.15 percent. Fund expenses: approximately 0.50 to 1.50 percent. Total: approximately 1.90 to 2.90 percent per year. On a $200,000 account, this equates to $3,800 to $5,800 per year.

Variable annuity with riders. Base fees as above, plus rider fees of 0.50 to 1.50 percent per year. Total: approximately 2.40 to 4.40 percent per year. On a $200,000 account, this equates to $4,800 to $8,800 per year.

Fixed indexed annuity without riders. No explicit annual fees. Costs are embedded in caps and participation rates. Surrender charges apply. Total visible cost: approximately zero percent per year in explicit fees.

Fixed indexed annuity with income rider. Rider fee of 0.50 to 1 percent per year deducted from account value, plus embedded costs in caps and participation rates. Total explicit cost: approximately 0.50 to 1 percent per year.

Fees compound over time. A two percent annual fee may seem small, but over 20 years it can reduce your account value by more than a third compared to an identical investment with no fees. Always calculate the long-term impact of fees before committing to an annuity.

Questions to Ask Before Buying an Annuity

Asking the right questions can help you avoid surprises and make a more informed decision. Here are the most important fee-related questions to ask any agent or advisor before purchasing an annuity.

• What is the total annual cost of this annuity, including all fees, charges, and embedded costs?
• What is the surrender charge schedule, and how long does the surrender period last?
• How much can I withdraw each year without a surrender charge?
• What is the M&E charge, and is it higher or lower than the industry average of 1.25 percent?
• What are the expense ratios of the available sub-account investment options?
• What commission does the selling agent or advisor receive, and how does that affect the contract terms?
• Are there any market value adjustments that could reduce my surrender value beyond the stated surrender charge?
• What riders are available, how much does each one cost, and can I add or remove them later?

Any reputable agent or advisor should be willing to answer these questions clearly and completely. If someone is evasive or reluctant to discuss fees, consider it a red flag.

The Bottom Line

Annuity fees vary widely by product type and can significantly impact your long-term returns. Variable annuities carry the highest explicit fees, commonly two to three percent per year or more with riders. Fixed annuities and indexed annuities have lower or no explicit annual fees, but their costs are embedded in the rate spread, caps, and participation rates.

Surrender charges apply to almost all annuity types and can trap your money for six to ten years or longer. Rider fees add another layer of cost for optional benefits that may or may not be worth the price. Hidden costs like commissions, market value adjustments, and rate spreads further affect what you actually earn.

Before purchasing any annuity, get a complete breakdown of every fee, calculate the total annual cost, and understand how those fees compound over time. Ask every question on the list above. Compare multiple products. And consult a qualified financial advisor who can help you determine whether the annuity's benefits justify its costs for your specific financial situation.