Have Variable Annuities Earned a Second Look?Submitted by J. R. Banna + Associates on October 17th, 2015
While there have been plenty of reasons to vilify variable annuities (high expenses, high surrender fees, sales charges), there may now be reason enough to take another look at them, especially if you’ve grown weary of the wildly gyrating stock market. In fact, the variable annuities being offered in the marketplace today may just be the ideal investment for anyone, young or old, who wouldn’t mind reaping the rewards of the market while virtually eliminating the downside risk. And, before the variable annuity critics jump all over this, we will mention that there is a cost for that. We’ll explain later.
The one distinct benefit that variable annuities have offered investors is the guaranteed death benefit which meant that their beneficiaries would receive, at a minimum, the principal investment upon the death of the annuity owner. That would have been a very significant benefit for beneficiaries who lost and investor-loved one following the 2008 stock market crash. And, it is also the reason behind the higher expenses of variable annuities. The issuing life insurer charges a mortality fee to provide that guaranteed death benefit. But, what if, in addition to protecting your beneficiaries against the loss of your principal or portfolio value, you could also protect yourself from losses in your portfolio. What would you pay for that?
It’s No Longer Your Father’s Variable Annuity
In recent years, annuity providers have been engineering their variable annuity products to create an opportunity for investors to enjoy the upside of the market without the downside risk. To that end, many variable annuity products now include additional guarantees that will protect your principal while you are living, ensure that your portfolio generates a positive return even during market declines, and provide you with a minimum amount of income regardless of the fluctuation in your investment account. In essence, variable annuity providers are now providing their investors with “sleep insurance.” And, an increasing number of variable annuity products are available with no sales charges and low or no surrender fees.
But all insurances come at a cost. We all pay insurance premiums to cover losses to our homes, our cars, our income, and our lives. With some of those coverages, we pay premiums all of our lives and never have to use them. Variable annuity contracts are now offering minimum guarantees that will protect you against the loss of principal or income due to stock market losses, which, will happen in the midst of stock market gains. The problem is that we mere mortals can’t predict when the losses will occur.
Minimum Rate Guarantee: Some variable annuities offer a minimum rate guarantee option that ensures that your investment accounts will be credited with a positive return even if the markets decline. The premium cost for this insurance ranges from .5% to 1% annual fee.
Minimum Income Guarantee: Variable annuities can generate an income, guaranteed for life that will track the direction of the stock and bond markets. As the markets rise, the income rises. But, as the markets decline, so too will the income. The minimum income guarantee will create an income floor below which the income cannot fall. Retirees can benefit from income increases in rising markets and be assured that they will receive a minimum income in declining markets. Premium cost: .5% to 1% annual fee.
Peace-of-Mind at What Cost?
Did we mention that the average annual expense of variable annuities, including mortality charges, administrative costs, and investment management fees, can range from 1.5% to 2.5%. So, if you add in the extra premium cost of minimum rate or minimum income guarantees, the total annual fee, collected from your account balance, can be as high as 4% - per year!
The question you have to ask yourself is whether that reduction in the annual return on your investment is worth the peace-of-mind knowing you won’t suffer the losses. If the stock market returns 20% in a given year, how concerned will you be with only a net 15% return when you know that your investment is protected during the inevitable down years in the market. And, don’t forget, those annual costs are at least partially offset the tax savings realize through tax deferral on your earnings. Annuity earnings are eventually taxed when they are withdrawn or received as income. And, early withdrawals, prior to age 59 ½ may be subject to a 10% IRS penalty.
Variable annuities never have been, nor will they ever be right for everyone. As with any investment, variable annuities should be evaluated for how closely they match your investment objectives, time horizon, and risk tolerance. For investors who have been able to achieve proper diversification among various types of investments, and who want to inject some predictability into their retirement future, the new variable annuities may warrant another look. But, it is important to carefully read the prospectus and compare all fees and sales charges.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2015 Advisor Websites.