Variable Annuity Investor Pitfalls

January 26, 2012

If you have siblings or are a fan of The Simpsons you are probably familiar with the “it’s their own fault” defense.

 

It works like this – Bart windmills his arms around in the air and hits Lisa. According to Bart, it was her own fault she was struck because he was only swinging his arm and Lisa happened to be in the way.

 

While perhaps in some way from Bart’s perspective this could be technically true, even a parent like Homer will see through this defense.

 

In a recent article I was quoted on how compared apples-to-apples that a variable annuity offers far less income than traditional income products, one option being an immediate annuity (I may have said something to the effect of if you have a half million dollars that you might take a hundred thousand or so to Vegas and have the same income as a variable annuity, depending on personal circumstances, and perhaps even more if you have a spouse).

 

A variable insurance company representative responded to that idea with the fact that an immediate annuity owner gives up control; and that a highlight of the variable annuity products that offer income benefits was that owners could leave the product.

 

While technically true, today’s variable annuity makes the ownership argument no more than a variant of the above sibling defense. Investors could leave a variable annuity and avoid a beating. We just all know they won’t. Here’s why:

  • Trapped by design. The variable annuity benefits involve two accounts – a real account that goes up and down based on the investments, and a hypothetical account that guarantees growth. Since the hypothetical account always grows, the insurer knows the investor isn’t going anywhere; they are sold on this guaranteed growth. Combined with the reality that this account is designed to exceed the real account value, and it has its own fees based on its value, and you get a fee that increases as a percentage of assets as the market declines. Increasing fees on lower assets means you will likely not come back from another market decline and be forced to rely on the variable annuity for retirement.

  • The increase is only good on the income. Investors in variable annuities are seeking guarantees for income, which means this is their product in retirement. In other words, they are not leaving, no matter if they could, and so if it means receiving 1/3 less income, perhaps they would benefit from other options that pay more income. Combine this with the fact that the VA promise is what is known as a guaranteed withdrawal benefit (meaning you withdraw all of your money first), which commits a variable annuity owner to the insurance guarantee because if you leave you lose your withdrawn funds and the higher guarantee.

  • Confusing dialogue. Over the last year we have seen a wave of companies leave the variable annuity marketplace. I find the dialogue on this to be very confusing to the average investor. In the past I have heard investors presented with products being pulled from the market as items they need to “buy now!” before they’re gone. And why wouldn’t you when you can “always leave” (less fees and any back-end sales charges and penalties). However, when presented in terms of the variable annuity being more like a recalled automobile whose faulty parts have incurred a higher than expected risk outcome, they have a different take on staying in a product that’s such a deal.

 

In summary, variable annuity owners get hit with high fees, lower income, and increased risk… but they could leave, if with plenty of bruises. Immediate annuities are just one option among retirement income strategies which may offer more income, a safer alternative, and can be designed with guarantees that retain some control. 

 

The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes. http://www.forbes.com/sites/feeonlyplanner/

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