It’s becoming as common as night following day. Sales of traditional variable annuities (VAs) have continued to decline for yet another quarter. According to the Insured Retirement Institute, VA sales totaled $26.4 billion in the second quarter, down nearly 2 percent for sales in the first quarter and a whopping 25.8 percent from the second quarter of 2015.
What’s going on? The conventional wisdom is that the stock market, in which VAs invest, has experienced bouts of sharp volatility this year – notwithstanding relative calm in recent months – and this tends to hurt VA sales. Moreover, the gains we have seen have been modest, and pundits widely expect market returns in coming years to fall below historical averages.
As a White Paper sponsored by Jefferson National suggests, however, this may not be the whole explanation. Growing sales of low-cost “investment-only” VAs, which are not tabulated in sales figures for traditional VAs, are also undercutting typical VA sales. These do not offer guaranteed income riders, which seem appealing but are expensive – about 1 percent a year – and eat into total return.
The White Paper examines when a VA with a lifetime income rider is worth the cost of the additional protection it provides, and when a less expensive low-cost better fits an investor’s needs. The research indicates that client preferences and characteristics will largely determine whether the low-cost investment-only VA is more attractive than a variable annuity with an income guarantee.
For certain annuity investors, it underscores this: “There can be more efficient ways to obtain upside potential and downside protection than by buying a guaranteed VA.”
The study is worth reviewing if for no other reason than that its author, Wade Pfau, a CFA® and Princeton PhD, is among the premier retirement scholars. He is a professor of retirement income at The American College of Financial Services and co-editor of the Journal of Personal Finance.
The White Paper explores how well an unguaranteed investment-only VA can replicate a rider’s guaranteed income payments. It’s based on an analysis of 5,000 Monte Carlo simulations on a low-cost investment-only VA and a traditional, hypothetical VA with a rider, combining characteristics of more than 30 popular guaranteed VAs and using more than eight decades of market data.
One fundamental conclusion: Just as the power of tax-deferred compounding can grow wealth, its corollary is that the drag of compounding fees can reduce wealth.
According to the White Paper, whether a low-cost VA makes more sense for an investor than a traditional VA with a lifetime income rider depends on variables such as the length of tax-deferred accumulation before taking withdrawals, optimism about future market performance, and comfort with more aggressive investment objectives. A low-cost VA may also be best for those with below-average expectations about remaining longevity.
— Steve Kaufman
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