What are commission-free annuities and are they good for retirement?

Annuities are often popular with retirees and those looking to retire because of the steady income stream they can provide. But annuities tend to come with high costs and commissions for salespeople, often masquerading as financial advisors, that eat into investors’ returns.

Some firms now offer annuities without commissions, which could be better for investors. Here’s what you need to know about commission-free annuities.

What are annuities and how do they work?

Annuities provide a stream of income in return for money being paid into the annuity. You may deposit a lump sum of money when purchasing the annuity or make payments to a life insurance company over time.

Annuities are often used as a part of someone’s retirement plan and can be customized based on a client’s needs. An annuity may pay out over a fixed period of time or it may provide income for the remainder of someone’s life, which is attractive for retirees looking for financial security.

However, annuities can be complex and can come with high fees. Historically, annuities have been associated with high sales commissions for the agents that sell them, often running 6 percent or more. These commissions create an incentive for agents to sell annuities even if they aren’t necessarily the best choice for investors.

What are commission-free annuities?

Commission-free annuities are what they sound like: annuities that don’t include a commission to the salesperson. These annuities, also called no-load annuities, typically have lower costs than annuities that include commissions.

Commission-free annuities are designed to offer the following core benefits, among others:

• Lower costs: By eliminating sales commissions, these annuities can significantly reduce the overall costs for investors, potentially leading to higher returns.
• Transparency: Commission-free annuities often have a more transparent and straightforward fee structure, making them easier for investors to understand.
• Alignment with investor’s interest: As these annuities are often offered by fee-only financial advisors, they can be more aligned with investor interests.

That being said, even these annuities can come with fees you may not expect, and they directly limit the return you ultimately earn as an investor. It’s worth consulting with a financial advisor who’s a fiduciary before buying an annuity to make sure you understand exactly what you’re buying and what you’ll get in return. The more complicated your annuity is, the more expensive it’s likely to be.

Keep in mind that many people who sell annuities call themselves financial advisors, but a fiduciary is required to put your interests before their own. If you’re looking for a financial advisor in your area, consider using Bankrate’s financial advisor matching tool.

The role of financial advisors in commission-free annuities

Financial advisors play an important role in the selection and performance of commission-free annuities. Advisors who charge fees and do not receive commissions may recommend these products. This arrangement allows the advisor’s interests to align with those of the client, as their earnings come from the advice they provide, not from selling insurance contracts.

However, it’s important to note that even with a commission-free setup, the overall cost will depend on multiple factors, such as the specifics of the annuity product, the advisor’s fees and the performance of the underlying investments within the annuity.

The business model of commission-free annuities

Commission-free annuities primarily generate revenue for insurance companies via management and administrative fees, as well as mortality and expense risk charges. Despite excluding the upfront sales commission, these annuities can still come with other fees such as surrender charges and costs for specialized features and add-on riders that can impact an investor’s return.

Commission-free annuities: Are they good for retirement?

Many retirees are attracted to the concept of annuities because they can provide an income stream for the rest of your life, similar to the way defined benefit pension plans work. Annuities also allow for tax-deferred growth.

However, annuities can be complex and may contain layers of fees, even if you avoid paying a commission. You may be better off contributing to an IRA, which you can set up for free at most online brokers, and investing in low-cost index funds. You can likely keep your annual expenses to less than 0.20 percent, whereas annuity costs can run significantly higher.

Annuities may be a good fit for high-earners who are looking to boost their retirement savings beyond what they can contribute to accounts such as 401(k)s or IRAs. Annuities don’t have contribution limits, so you can put as much money into an annuity as you’d like.

Bottom line

Annuities are popular with retirees because they can provide a stream of income for a certain period of time or even for the remainder of their lives. However, annuities often have high fees and can come with huge commissions for salespeople. Commission-free annuities may be a better choice, but be sure you understand all the fees you’ll be paying before signing on the dotted line.

Consider consulting with a fee-only financial advisor who acts as a fiduciary before purchasing an annuity. They may be able to help you identify alternatives to annuities that have lower costs and allow you to keep more of your hard-earned money.

—Bankrate’s Rachel Christian contributed to an update of this article.