I’ve noticed an increasing number of people contacting me about variable annuities lately. I think this can be explained by a fear increase among investors. In the past investors may have been willing to forego a guaranteed income stream for the chance at having substantially more assets during retirement. That mentality made sense at a time when the stock market averaged 10-12% growth per year and government entitlement programs were well funded. But during this ‘lost decade’ investors find themselves clinging to cash and prioritizing guaranteed income over growth. Variable annuities actually offer both which is probably why investors are asking questions.
Variable Annuities are long-term investments designed for retirement. They may come with optional living benefits, which, for an additional fee, guarantee that the investor get back at least what they put into the contract through periodic payments—regardless of market performance. However, if the underlying investments (generally stocks and bonds) grow in value, the contract holder can ‘lock-in’ a higher base from which to take income. An ideal scenario would work something like this: You put $100,000 in a variable annuity at age 60. The contract value grows to $200,000 over the next ten years. The contract value then declines to $140,000 over the next two years. Because of your living benefits rider, your income base locks in that $200,000 level and you are able to take 6% withdrawals for life, based on $200,000, at age 70. If you live to 95, you’re guaranteed $12,000/year for 25 years, or $300,000 in payments, regardless of market performance.
Variable annuities are often criticized for being complex and expensive—both of which are true. Part of the reason why annuities often seem ‘too good to be true’ is due to their complex nature. When you hear ads offering “Guaranteed Income for Life,” that offer is real. But here are some good due diligence questions to ask a financial advisor prior to jumping in:
•How much income?
•At what age can I start taking that income?
•What goes to my beneficiaries if I die?
•How much does it cost me?
I’ll answer those questions in order which will hopefully clarify to some extent how the insurance companies work and where you could potentially get trapped.
•The amount of income you get is based on your age. A typical variable annuity may offer you 5% of your income base for life if you start taking withdrawals at age 65. If you wait till 70, you may get 6% and if you wait for 75 or 80, you’d get 7%. Over the past few years, those numbers have become slightly less favorable for investors as the insurance companies have had a harder time ‘hedging’ their riders and making money in the market with which to pay those guarantees. Obviously the exact terms of each payout vary from company to company.
•Like I mentioned above, the earlier you start taking income, the lower the percentage will be. For obvious reasons, the insurance company is trying to protect themselves from having to pay you too much money during your lifetime. You would more than likely be putting yourself at an advantage if you knew you would live past age 100 with most of these annuity products.
•With most variable annuities, it’s a misconception that your beneficiaries get nothing if you die. What they generally get with a typical VA with a living benefits rider is the market value of the contract less any withdrawals which you may have taken. As we mentioned above, certain contracts have riders which will allow the contract holder to obtain income bases which are higher than the contract value. It’s important to note that the contract value and the income base are two separate numbers. The contract value is simply the value of the investments which fluctuate in the market and is affected by contract expenses and withdrawals.
•In terms of costs and expenses, the average variable annuity in 2009 had annual expenses of 2.44% including insurance and investment expenses (According to Morningstar Research). The most desirable living benefits including “GMWB” (Guaranteed Minimum Withdrawal Benefit) usually run another .5 to 1%, bringing the total annual costs somewhere between 2.94% – 3.44%. Is that a lot? Yes. It’s potentially over $3,000 per year on a $100,000 contract. You’re paying for a guaranteed income stream in the future, regardless of how your investments perform.
Like many things in financial planning, there’s no right or wrong when it comes to variable annuities. For some clients it will be right for others it won’t be. Along those lines, I generally don’t recommend that clients put all of their eggs in one basket. An annuity may be good for insuring some portion of your retirement income while the rest of your savings can be invested elsewhere.
As always, please feel free to contact me with questions or comments.
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
Guarantees are based on the claims-paying ability of the issuer. Surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value. Optional riders may involve additional fees.
A rider is a feature designed to achieve a goal, attached to a variable annuity contract for an additional fee.
This graph depicts the advantages of tax-deferred compounding. Assumptions are a $50,000 initial investment with an 8% rate of return over a 30-year time horizon. The assumed tax rate is 28%. This graph is for illustration purposes only. Expenses were not included for this illustration. If they were, the return would be lower.
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.