There are four costs associated with variable annuities:  a possible upfront sales charge (similar to mutual fund A Shares),  sliding scale surrender charges (typically range from 0-8%),  insurance charges (i.e., mortality and expense, administrative, and possible distribution),  management fees (expense ratio, similar to mutual funds), and  an additional annual expense if a rider is chosen). Many variable annuities have a $30-$50 annual contract maintenance charge for contracts (or cumulative deposits) worth < $50,000.
A modest number of variable annuities have an upfront sales charge. If there is such a charge, other costs associated with the contract are typically lower. The typical surrender charge is ~ 7-8% and the penalty period frequently lasts 7-8 years. Withdrawals or contract surrenders past this period are not subject to any kind of surrender cost. However, whenever any new money is added to a variable annuity, the new money has its own surrender period.
For example, Ed invests $100,000 in a variable annuity with a 7-year surrender period. Three years later, Ed adds another $20,000 to the contract. For years 4-11, the $20,000 will be subject to a possible surrender charge. After the initial seven years, the $100,000 deposit (and any growth associated with it) will not be subject to a back-end fee or charge.
According to 2012 Morningstar figures, the average M&E expense for a variable annuity was 1.25%, the average management fee (expense ratio for the subaccount) was 0.97%, the typical administrative fee and other standard costs came to 0.28%, for a total of 2.35%. If you add a living benefit rider, the average cost then becomes ~ 3.4%. An enhanced death benefit would drive annual costs even higher.
One way to explain a variable annuity with a living benefit to a client is: “You have all the upside potential of the investments owned by the subaccounts you are in minus ~ 3.4% a year (hidden), with certain guarantees while you are alive (i.e., 5% withdrawal per year, annual reset, etc.), indefinite tax deferred growth potential, and a standard death benefit).
Variable Annuity L and P Shares
Variable annuity L Shares provide a shorter penalty period, frequently 3-4 years instead of the usual 7-8 years. The cost for the shorter surrender period is a higher annual M&E charge (often 0.25% extra per year). P Shares have lower annual expenses, but the penalty (surrender) period is longer.