The Absolute Regarding Variable Annuities

Absolutes would work great in this business if every client had the same amount of money, the exact same goals, similar value systems, accepted the same level of risk, were the same age, and had the same exact life expectancy. However, no two people are exactly the same. Thus, we would do best to stay away from absolutes.

Are variable annuities good investments? Yes, for some investors, but probably not most. Again, it depends on many things but primarily your goals and how comfortable you are with your future projected income stream in retirement.

The reason I am comfortable stating this is due to the empirical studies concluding that variable annuities, specifically the living benefits (a guaranteed lifetime withdrawal amount), may be a good option to a specific subset of investors. These articles include:

• “Valuing Variable Annuities with Guaranteed Minimum Lifetime Withdrawal Benefits” by Petra Steinorth, Peter J. Tobin, and Oliva S. Mitchell. Pension Research Council 2012
• “The Cost of Guaranteed Income: Demystifying the Value Proposition of Variable Annuities with Guaranteed Lifetime Withdrawal Benefit Riders” by Rosita P Chang, PH.D., CFA, CFP®; Jack C DeJong, Jr PH.D., CFA; Qianqiu Liu, PH.D.; John H Robison; and Jack Suyderhoud, PH.D. Retirement Management Journal 2014
• “Allocation to Deferred Variable Annuities with GMWB for Life.” James X. Xiong, Ph.D., CFA®; Thomas Idzorek, CFA®; Peng Chen, Ph.D., CFA®. Journal of Financial Planning February 2010.

The intent of this article is not to push variable annuities but rather educate investors that absolutes do not work in this business and that most every investment has its time and place; even if it is a small percentage of cases. Be careful in taking the words of these media “experts” at face value.

To be fair, I agree with the primary weaknesses stated about variable annuities, which is their high fees, relative to other options like a stock portfolio. There are other weaknesses, including but not limited to, liquidity issues, poor tax treatment at death, and misuse by many financial professionals.

However, any discussion regarding variable annuities, from my perspective, must first start with the fees. It is a question of how much is each person willing to pay to have a guaranteed withdrawal amount? No one can answer that for an investor.

So, who may benefit from a variable annuity with a guaranteed withdrawal benefit? It may be a fit for those that want to ensure a known withdrawal amount for an extended period of time, who expect due to family history of a long life, are risk adverse, and have minimal bequest motives. Annuities, more than likely, will not be a fit for aggressive investors, with little need for withdrawal guarantees. For compliance purposes, I have to add the “more than likely” but I just don’t see an annuity as a good fit for an investor whose primary focus is maximizing return. You should expect to get less of a return due to the high fees.  Again, there is a cost to everything, including the guaranteed lifetime withdrawal.

One of the other issues of annuities, variable or fixed, is misuse by brokers. Some red flags that you are being pushed into a variable annuity include:

• You are being asked to take a surrender penalty on a current annuity in order to invest in a new annuity. I have yet to see a case in which this makes sense, even considering a “bonus” from the new insurance company.
• You are asked to roll a current annuity, with no surrender penalty left, into a new one with a surrender penalty. Not only do you now have a new commitment, your fees will more than likely increase.
• You are being presented with an annuity with a long surrender penalty (7+ years). The rule of thumb to always remember is the longer the surrender penalty for the investor, the larger the commission for the broker.
• There isn’t an in-depth discussion regarding all of the fees.

We here at Virtus Wealth Management hope when you listen to the media’s experts regarding any investment, you understand absolutes do not exist in personal financial planning. The media sells based on the number of viewers, readers and clicks, not on their understanding of your specific financial situation. Thus the absolute regarding annuities, is there are no absolutes.