Introduction
Variable annuities offer the potential for higher returns based on the performance of underlying investments, usually a selection of mutual funds. The Securities and Exchange Commission consider variable annuities to be securities. As part of the Securities Act of 1933, issuers of a variable type annuity are required to provide a summary prospectus to an annuitant and a statutory prospectus available online (Rule 498A).
For any security it is important to understand the prospectus before investing. This document contains important information such as: company's profile, the securities offered, investment objectives, the use of capital, and risk factors. You don’t have to be a financial expert to read and understand a prospectus. The purpose of this article is to provide a brief discussion on a prospectus and what to focus on.
What is an Annuity Prospectus?
From Investopedia, “A prospectus is a written document used in finance to inform the public of the relevant details about an offering of securities, such as stocks, bonds, and mutual funds.”
As stated above, this document is required by law to be available and provided to potential and current investors in a security. Typically, a prospectus will be available for variable, indexed and some fixed annuities. To be clear, this is a disclosure document and NOT a marketing brochure. The information tabulated below is taken from Corebridge Financial, a popular annuity provider:
| Document Type | Description |
|---|---|
Initial Summary Prospectus | Provided for you to consider before you purchase a variable annuity product; more concise and reader-friendly than the long-form prospectus. |
Updating Summary Prospectus | For current variable annuity product owners, summarizes any changes that took place since the last annual update. |
Prospectus (Long Form) | A longer document, also known as a “Statutory Prospectus”; provides a more detailed level of information. |
Statement of Additional Information (SAI) | A supplement to the prospectus that provides additional information about an annuity product and detailed operational disclosures. |
Investment Options | Provides fund prospectuses for the investment options available within a specific annuity product. |
Key Sections to Focus On
As previously stated, these are disclosure documents required by law. Every prospectus for an annuity provided by an insurance company contains similar sections. Below are some important pieces of information to review.
Product Overview
An overview of the product should be described explaining what kind of annuity it is (variable, indexed, fixed). It will also contain information on the basic features and objectives of the investment (income, growth, protection). Some products may be more or less aggressive depending on the underlying investments. This section of the prospectus should indicate how it fits different financial goals.
Fees and Expenses
There should be a section clearly stating what fees are applicable to the product described. Examples of types of fees are shown below:
| Type of Fee | Explanation and Example |
|---|---|
Mortality and Expense (M&E) Risk Fees | These fees cover insurance risks and guarantee that the insurance company will provide payments even if the annuitant lives longer than expected. Example: An annual charge of 1.25% of the account value. |
Administrative Fees | Administrative fees cover the costs of managing the annuity contract and other administrative expenses. Example: A flat annual fee of $50 or a percentage of the account value, such as 0.15%. |
Investment Management Fees | These fees are charged for managing the investment portfolio within a variable annuity. Example: An annual fee of 0.75% of the account value. |
Surrender Charges | Surrender charges are fees paid when the annuity is cashed out or terminated early. Example: A charge starting at 7% in the first year and decreasing annually over a seven-year period. |
“Fee drag” on investments can be a concern if fees or expenses are relatively high. Be sure to fully understand the costs of the product you are looking to purchase.
Investment Options
This section of a prospectus will discuss the different investment options available for that annuity. It will include information on the risk levels and asset classes. This is an important section to determine if the product aligns with your personal risk tolerance.
Riders and Optional Benefits
An annuity rider is a feature that can be added to an annuity contract to provide additional benefits or options to the annuity holder. This section of the prospectus will include the types of riders available, the benefits of the rider as well as the cost. It is important to read this section carefully for the fine print on any benefit or rider you are interested in.
Risks
Sections of the prospectus will discuss risk at different levels. There are the risks of investing in the market. But just as importantly, there will be sections covering the history of the company, its strategy and objectives as well as its goals for the product you are researching. They also should include any applicable credit agency ratings for their company. A key to annuity buying is investing in a company with a good track record and solid strategy.
Payout Options
There are different annuitization choices available: lifetime income, period-certain, joint life, etc. Different type of payout structures will affect your retirement income differently. Be sure to read this section carefully to understand how the product fits into your retirement income goals.
| Type | Description | Payment Characteristics |
|---|---|---|
Lifetime (Life Only) | Income for the rest of your life | Highest monthly payment, nothing left for beneficiaries |
Joint and Survivor | Lifetime income for you and another person | Payments continue until the second person dies, lower monthly amount |
Period Certain | Income for a fixed period (10 years, 20 years, etc.) | Payments continue to beneficiary if you die during the period, stop at end of term if you outlive the period |
Life with Period Certain | Combination of life and fixed period income | Lower monthly payments, guarantees payments for life or a certain number of years |
Tips for Making Sense of the Prospectus
Every prospectus will begin with a summary section. Be sure to read this section carefully as well as the table of contents to know exactly what information you want to research. If you want to save some time, skim the document and look for tables and charts. Visuals oftentimes better explain the information than reading paragraphs full of finance or legal jargon. Also, take advantage of AI. Use a large language model (LLM) such as ChatGPT. Most LLMs will allow you to upload documents to them. Once you do that, you can prompt the model and ask questions of the prospectus.
You can use the following example prompts to get you going.
| Category | Prompt |
|---|---|
Summary | “Provide a summary overview of the annuity prospectus.” |
Fees | “List and explain all fees associated with this annuity.” |
Risk | “Describe the potential risks mentioned in the prospectus.” |
Performance | “What is the historical performance of this annuity?” |
Guarantees | “What guarantees are provided with this annuity?” |
Options | “Explain the lifetime income options and their terms.” |
Period Certain | “Describe the period certain income options available.” |
Life with Period Certain | “Detail the life with period certain options and their benefits.” |
Conclusion
Reading an annuity prospectus can seem intimidating, but it is manageable with the right approach. Taking the time to understand it can save thousands of dollars and prevent future surprises. Remember, you don't need to understand everything, you just need to know where to look and what questions to ask.
It's normal to feel confused when navigating annuities; many people seek guidance from financial advisors and licensed insurance brokers. It's important to ask direct questions about any unclear topics, and always remember to seek independent advice, not just from the person selling the annuity.