What Is L Share Annuity Class?
An L share annuity class is a specific type of variable annuity contract distinguished primarily by its shorter surrender charge period, typically lasting three to four years. In exchange for this abbreviated period of liquidity restriction, L share annuities generally carry higher ongoing fees compared to other variable annuity share classes. This structure aims to appeal to investors who may anticipate needing access to their funds sooner than the longer surrender periods often associated with other annuity structures, while still benefiting from the tax-deferred growth offered by the investment product. The L share annuity class is part of the broader category of investment products known as annuities, which are contracts between an individual and an insurance company designed to provide a stream of income in retirement.
History and Origin
The concept of annuities dates back to ancient Roman times, but modern variable annuities, which allow for investment in underlying separate accounts, gained prominence in the United States following the mid-20th century. The expansion of these products saw the introduction of various share classes to meet diverse investor needs and preferences regarding upfront costs, ongoing fees, and access to funds. The emergence of the L share annuity class specifically addressed a market demand for shorter commitment periods, distinguishing itself from longer-term options like B share annuities. This evolution reflects the industry's response to investors seeking more flexibility, while balancing the insurer's need to recoup distribution and administrative costs over a shorter timeframe. The rapid expansion of variable annuities in the U.S. market was particularly notable in the latter half of the 20th century, combining the investment features of mutual funds with tax deferral benefits.5
Key Takeaways
- L share annuity classes feature a significantly shorter surrender charge period, typically 3 to 4 years, compared to other variable annuity share classes.
- In exchange for this shorter surrender period, L share annuities often have higher ongoing annual fees, particularly the mortality and expense risk charge (M&E) and administrative fees.4
- They are designed for investors who prioritize potential liquidity and access to their funds earlier in the contract's life.
- Like other variable annuities, L shares allow for investment in a range of subaccounts and offer tax-deferred growth during the accumulation phase.
- The higher fees of L share annuities can reduce overall long-term investment returns compared to contracts with lower ongoing costs.
Interpreting the L Share Annuity Class
Interpreting an L share annuity class involves understanding the trade-off between liquidity and cost. The primary characteristic of an L share annuity is its shortened surrender period. This means that if the contract holder needs to withdraw funds beyond the penalty-free amount before the surrender period ends, they will face a lower or no surrender charge penalty sooner than with other share classes. However, this flexibility comes at a price. L share annuities typically have higher annual fees, notably higher mortality and expense (M&E) charges and administrative fees, which are ongoing costs throughout the life of the contract, even after the surrender period expires.3
For an investor, this implies that while they gain earlier access to their funds, the higher recurring fees can erode the overall value of their investment options over time. Therefore, the suitability of an L share annuity depends heavily on the individual's anticipated need for liquidity and their long-term retirement planning goals. If early access is a strong possibility, the L share might be considered. However, if the intent is truly long-term accumulation phase without withdrawals, the higher ongoing fees could make it less financially efficient than other annuity share classes.
Hypothetical Example
Consider an investor, Sarah, who has $100,000 to invest in a variable annuity. She is evaluating two options:
- Standard B Share Annuity: This annuity has a 7-year surrender period and a combined annual mortality & expense and administration (MEA) fee of 1.15%.
- L Share Annuity Class: This annuity has a 3-year surrender period and a combined annual MEA fee of 1.65%.
Both annuities offer the same underlying investment options, and for simplicity, we assume a hypothetical gross annual investment growth rate of 7% for both.
Scenario 1: Sarah needs to withdraw all funds in Year 4.
- B Share Annuity: In Year 4, the B share annuity would likely still be within its surrender period, potentially incurring a penalty (e.g., 4% of the amount withdrawn). If her account grew to, say, $120,000 after fees and growth, a 4% surrender charge on withdrawal would be $4,800.
- L Share Annuity: In Year 4, the L share annuity would be outside its 3-year surrender period, meaning Sarah could withdraw her funds without incurring a surrender charge from the insurance company. While the L share had higher annual fees reducing its growth slightly, the absence of a surrender charge in Year 4 might make it more attractive for her specific liquidity need.
Scenario 2: Sarah keeps her investment for 10 years without withdrawals.
Let's look at the impact of fees over a longer period.
- B Share Annuity (1.15% MEA): Over 10 years, the lower ongoing fees would allow the account value to grow more substantially due to compounding.
- L Share Annuity (1.65% MEA): Over 10 years, the higher ongoing fees of the L share annuity would consistently reduce the net return, leading to a lower overall account value compared to the B share, assuming all other factors are equal. The initial benefit of a shorter surrender period becomes less relevant as the holding period extends beyond it.
This example illustrates that while the L share annuity class offers quicker access, a financial professional would emphasize that its higher ongoing costs may make it less suitable for investors who intend to hold the annuity for a long duration, such as through to annuitization in retirement.
Practical Applications
The L share annuity class finds practical application for investors who anticipate a need for liquidity relatively soon after purchasing an annuity, typically within three to four years. This could include individuals who are nearing retirement but are unsure of their exact income commencement date, or those who wish to keep their options open for future asset allocation adjustments. It is often considered by those who value the flexibility of a shorter commitment period, even if it comes with higher annual fees.
While variable annuities are long-term investment vehicles, the L share class can serve as a bridge for certain retirement planning scenarios. For example, an individual might use an L share annuity if they plan to retire in 3-5 years and want to retain the ability to reallocate funds or begin drawing income without facing substantial penalties from a longer surrender schedule. However, it's essential for investors to understand the full fee structure of any variable annuity, including administrative fees and underlying fund expenses, which can significantly impact returns. The Securities and Exchange Commission (SEC) provides guidance emphasizing the importance of understanding all charges associated with variable annuities.2
Limitations and Criticisms
Despite offering a shorter surrender period, the L share annuity class faces notable limitations and criticisms, primarily due to its higher ongoing fees. The increased mortality and expense risk charge (M&E) and administrative fees associated with L shares can significantly erode the overall return on investment, especially over longer holding periods. This means that while an investor gains earlier access to their funds without incurring a surrender charge, the cumulative effect of higher annual fees can result in a lower account value compared to annuities with longer surrender periods but lower costs.
Critics often highlight that these higher fees can disproportionately impact long-term investors, for whom the benefit of a shorter surrender period becomes negligible after the period expires. The Financial Industry Regulatory Authority (FINRA) emphasizes that financial professionals must have a reasonable belief that a deferred variable annuity recommendation, including its share class, is suitable for a customer's specific needs, objectives, and time horizon, considering factors like fees, surrender charges, and the loss of existing benefits during exchanges.1 Some financial analyses suggest that for investors who do not anticipate needing early access to their funds, the higher costs of an L share annuity might outweigh the benefit of its shorter surrender period, leading to a less favorable financial outcome over time.
L Share Annuity Class vs. B Share Annuity Class
The L share annuity class and B share annuity class are two common share structures within variable annuities, primarily differing in their surrender charge periods and ongoing fees.
| Feature | L Share Annuity Class | B Share Annuity Class |
|---|---|---|
| Surrender Period | Shorter, typically 3 to 4 years. | Longer, often 5 to 7 years (or more). |
| Ongoing Fees (M&E) | Generally higher annual fees. | Generally lower annual fees. |
| Sales Charge | Typically no upfront sales charge. | No upfront sales charge; deferred sales charge applies if surrendered within period. |
| Liquidity | Earlier access to funds without penalty. | Later access to funds without penalty. |
| Ideal For | Investors seeking earlier liquidity. | Investors with a longer time horizon, less need for early access. |
The core distinction lies in the trade-off: the L share annuity class provides greater flexibility for early withdrawals by having a shorter surrender charge period, but it levies higher ongoing annual fees, such as the mortality and expense risk charge. Conversely, the B share annuity class typically has lower ongoing fees but requires a longer commitment to avoid surrender penalties. For a variable annuity, the choice between these classes depends significantly on an investor's expected holding period and their potential need for future liquidity.
FAQs
What are the main advantages of an L Share annuity?
The primary advantage of an L share annuity is its shorter surrender charge period, usually 3 to 4 years. This allows investors to access their funds without penalty much sooner than with other variable annuity share classes, which often have surrender periods lasting 7 years or longer. This can be beneficial for those who anticipate needing more liquidity in the near future.
Are L Share annuities suitable for long-term retirement savings?
While L share annuities offer tax-deferred growth, their higher ongoing annual fees can make them less suitable for very long-term retirement planning compared to other annuity classes with lower fees. Over many years, the cumulative impact of these higher fees can significantly reduce the overall account value. For investors whose primary goal is long-term growth and eventual annuitization, other share classes might be more cost-effective.
How do the fees of an L Share annuity compare to other share classes?
L share annuities generally have higher ongoing annual fees, particularly higher mortality and expense risk charges and administrative charges, compared to B or A share annuities. This higher cost is the trade-off for their shorter surrender charge periods. Other share classes like C shares might have no surrender charge but carry similar or even higher ongoing fees, while I shares might have lower fees and no surrender charge but are often available only through fee-based advisors.