A Sea Change in Variable Annuities

I have been anti-variable annuity for so many years it has become second nature to me.

Fee-only financial advisors avoid them like the plague, and financial journalist are very wary of them.  The only party involved with them that benefits is the insurance agent, calling themselves financial advisors, who earn 7 to 8% commission by selling them and the broker/dealer who splits that with the agent.

Of course those agents and advisors involved with the sale of variable annuities scream if someone dare discuss the negative issues about one of the most lucrative products available to them. Rightfully so, there are many reasons not to purchase them, no one wants to talk about them and if they do, sales would certainly drop like a rock.

The adage in the industry is that “variable annuities are sold, not bought” is very accurate.  Insurance companies spend billions on advertisements (i.e. a gorillas in an elevator) extolling the pitfalls of living longer than your assets last. Obviously it is very effective; sales were up 16% during 2011. Caveat emptor is falling on deaf ears.

For the most part, the public takes it on the chin.

Just what is a Variable Annuity?

Like any annuity, it has an insurance base which allows it to remain tax-deferred (not tax-free) similar to a life insurance policy.  The difference is that unlike a fixed annuity, variable annuities have a mutual fund type account supporting the values. If the fund values increase, your annuity values increases. If the fund values decrease, the annuity value decreases.  Like a mutual fund those values change every day.

There are several problems with variable annuities; taxation of distributions, use in an IRA, a 10% early withdrawal penalty, surrender periods, not mention that it is a lousy estate planning tool.

My two biggest complaints.

Variable annuities are notorious for the fees.  By the time the annual contract fee, fee for the mutual fund component, insurance costs, marketing fees and whatever else they can come up with is totaled, you could very easily be looking at 3 to 5% per year in ongoing fees.

Then they have the gall to try to sell you an additional rider to guarantee you will get your money back.  Try to read the fine print on that one!

The other issue if have with variable annuities is that surrender periods, and their related fees, can tie up YOUR money for years, upwards of 15 years. That makes them very illiquid and that, along with the lack of a step at up death benefit for heirs, can make them a nightmare for estate planning.

Partial change of heart

Over the last couple of years, the insurance industry has been adjusting their products to accommodate a larger group of people, both advisors and customers.  Most of this change is in the form of my favorite complaints, fees and surrender period.

Several insurers have decided that maybe, just maybe, the fees were too high.

A few of them have developed a hybrid minimum fee contract many of which eliminate the annual fee, get the insurance cost to around 0.20% and has lowered the annual administration fee to be closer to reality.  These hybrid contracts can get the annual expense ratio down from 5.0% to 0.45% which makes a huge difference.

My other major problem with variable annuities was the surrender period and the fees that went with those.  The traditional contract paid the insurance agent a commission as a percentage of the premium paid and an annual renewal commission as long as the agent could keep you in the policy.

In order to recoup the commission, the insurance company would charge you, the consumer, a surrender fee if you terminated the contract within the first several years.  Usually 10 to 15 years.

The hybrid contracts do not pay a commission and, therefore, do not need to impose a surrender period or the fee associated with the surrender.  That means that you, the consumer, have immediate liquidity of the money you put into the annuity.  Very unique!!

Very unknown!!

Let’s see, no commissions. The single biggest reason, commissions paid to the agent, why variable annuities are “used” as an investment vehicle has been eliminated.  That means the agent has to have a valid reason to use the product…other than he/she needs to generate income for themselves.

What you are going to find is that the only advisors who are going to suggest this contract are “fee-only” advisors who cannot be paid commission to sell an annuity.  The fee-only advisor has no monetary gain by using the low-load hybrid variable annuity. Eliminating the commissions paid can do nothing but help the client as there is no longer a conflict of interest.

The new breed advisors

The next time your traditional commissioned “financial advisor” sits down to discuss variable annuities, ask him about the hybrid low-load products.  When he starts back-peddling by saying those contracts are not anything like his traditional variable annuity, ask him to write down the differences that make his better.

Take those “differences” to a fee-only advisor; pay him/her a couple of bucks and get a second opinion.  I would be willing to bet you will get a different view.  We can be reached at (813) 269-0732 if you would like our opinion.