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Low-Cost Variable Annuities May Be Better than Traditional VAs for Some Investors

Studies show that investors who sidestep paying for annuities with benefits they don't really need save themselves one to two percent a year.
Studies show that investors who sidestep paying for annuities with benefits they don’t really need save themselves one to two percent a year.

Despite declining sales in a see-saw stock market, traditional variable annuities are still the best-selling annuity. And if you looked at the entire variable annuity universe, which also includes so-called low-cost variable annuities, total VA sales would be several billion dollars a year higher than officially reported.

This gets scant attention because most people, including owners of traditional VAs, don’t know about low-cost VAs, and no annuity sales-collection organization, such as the Insured Retirement Institute or LIMRA, bothers tracking their sales.

This is worthy of attention if you are partial to the stock market. Depending on your financial parameters and investment philosophy, low-cost VAs may make more sense for you than traditional VAs. Like traditional VAs, low-cost VAs give you ready access to ample subaccounts (mutual funds) in which to invest, as well as tax deferral. What most don’t give you is a lifetime income rider. That is expensive, however, and, depending on your personal situation, may not be worth the price. Low-cost VAs don’t have surrender fees, either.

Studies show that investors who sidestep paying for annuities with benefits they don’t really need save themselves one to two percent a year.

The biggest vendor of low-cost VAs, — The Vanguard Group — sells about $1 billion worth of low-cost VAs a year and says nearly 75 percent of its business comes from traditional VA owners through 1035 exchanges. “These people figure they no longer need a lifetime income benefit or at least do not need it for a while,” says Tim Holmes, a senior manager at the Vanguard Retail Investor Group. “They can no longer justify the expense.”

He and others say the primary reason that annuities were introduced in the first place was the appeal of tax deferral, making them an enticing alternative to conventional stock and mutual funds and bank CDs, among other options. In the 1990s, the annuity industry became immersed in adding bells and whistles for competitive reasons, creating what is commonly dubbed a “features and benefits arm race.”

Because of high fees for lifetime income riders — coupled with a heightened desire to buy a VA principally for retirement savings, not an income stream — more people today are buying a low-cost VA instead of a traditional VA, low-cost VA proponents say.

Even people solely in the business of selling traditional VAs and other mainstream annuities, such as Andrew Murdoch, president of Portland, OR-based Somerset Wealth Strategies, see value in the low-cost VA. “When you buy an annuity, you should make sure you are paying for a benefit you actually need,” Murdoch says. “If you’re 70 years old and know you’re in a solid financial position and will not run out of money, why bother paying for an additional income stream?”

Wade Pfau, a Ph.D. and retirement income professor at The American College of Financial Services, says much the same thing. “Just as the power of tax-deferred compounding can grow wealth, its corollary is that the drag of compounding fees can reduce wealth, “ Pfau says. “There can be more efficient ways for clients to invest than by buying a traditional VA with a lifetime income benefit.”

Vanguard’s low-cost VA, underwritten by Transamerica, is the most comprehensive and, predictably, is very inexpensive.
The VA typically costs about 75 to 95 basis points annually, including mortality, expense and administration and sub-account fees. For those customers who also want a lifetime income rider — about 10 percent — that can be obtained for about an additional 50 basis points a year. These riders can be bought when the annuity is purchased or years afterward.

Another major low-cost VA player is Jefferson National, whose Monument Advisor VA is sold primarily through thousands of independent financial brokers. It offers 350 sub-accounts, a number that has more than doubled over the last decade. Buyers of Monument Advisor $20 per month, plus sub-account fees of roughly 1 percent annually and the financial broker firm’s advisory fee.

Fidelity Investments is also a major player in this space. Its low-cost VA costs 25 basis points a year. In contrast to competitors, Matt Murphy, a Fidelity vice president and financial consultant, says most Fidelity low-cost VA business comes not from 1035 exchanges but from Fidelity customers who transfer funds from taxable -qualified accounts to the low-cost VA to reap the benefit of tax deferral.

Also unlike competitors, Murphy isn’t sure low-cost VAs are better than traditional VAs. Rather, he says, they are merely different and cater to a more narrowly focused crowd. “There are good reasons for the additional fees that traditional VAs charge,” Murphy says. “A lifetime income benefit, in particular, is a very significant benefit. Where else can you get that but with a traditional annuity?”

Which type of VA is best for a particular customer depends on his or her priorities and needs. What is important is that prospective investors knows the landscape. Investors who know what annuities are out there before buying and their relative pluses and minuses, from their perspective, are far more likely to buy a product that best fits their needs.

Besides Low-Cost VAs, Consider Investment-Only VAs

Now that you are up to snuff regarding the low-cost variable annuity, you should also know about its cousin — a so-called investment-only variable annuity. This straddles the difference between a traditional VA, which is more expensive, and a low-cost VA, which is less expensive.

It is worth the higher price tag if you’re a sophisticated investor who wants access to exotic investments, such as stock funds that buy long and short, in addition to traditional mutual funds. An investment-only VA also comes with hands-on help from a securities-licensed financial advisor, for no additional fee. This is very helpful in sifting through a more complex investment arena.

“An investment-only VA is an excellent way to super-charge the allure of tax deferral with a truly diversified portfolio – in effect, an all-weather portfolio, and one with the theoretic ability to earn money almost no matter what is happening,” says Scott Sadar, a CFP and executive vice president at Somerset Wealth Strategies in Portland, OR.

The biggest vendor in this space is Jackson National, which sells its product –Elite Access — to qualified financial advisors. Since the product was introduced three-and-a-half years ago, it has garnered $15 billion in sales.

Elite Access is available for low minimum investments. Mortality, expense and administrative fees are .85 percent annually. A five-year surrender schedule can be eliminated for an additional .25 percent a year. Elite Access offers 100 sub-accounts (mutual funds) and other investment funds, roughly double the number of many traditional variable annuities, and most charge management fees of less than 1 percent annually.

Reflecting the case among most low-cost variable annuities, a lifetime income rider is not available.

Elite Access and other products of its ilk are special in offering an unusually eclectic mix of diversified investment funds. In addition to funds that buy stocks long and short, these include private equity funds, commodity funds, and futures strategy funds.

Sadar says Elite Access and similar products are worth the price if you’re a highly aggressive investor and want help from an investment expert. These products also offer investors more options in rebalancing their portfolios.

— Steve Kaufman

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