Arguments Against Variable Annuities Often Include Misinformation

Date posted: October 15, 2013

There are some people who vehemently oppose variable annuities, often without knowing the details of these products.  In Tom Hegna’s Producers eSource article, “The 3 Primary Variable Annuity Objections and How to Handle Them,” the author lists the three reasons that most people dislike variable annuities.  While these reasons may make a variable annuity the wrong product for some people, they are not accurate arguments against them for many others.  Misinformation sometimes leads consumers on a road away from variable annuities when they might be the right product for them.  People in their late 50′s who don’t have a pension and people with high income who have contributed all they can to their 401k plan are just two groups who should consider variable annuities.

Yes, variable annuities have fees.  Yes, they are higher than some other products.  But the fees are fair given all of the benefits that variable annuities offer you financially.  The fees for variable annuities are directly related to the guarantees that they offer.  Some have a Guaranteed Minimum Accumulation Benefit (GMAB), while others have a Guaranteed Lifetime Withdrawal Benefit (GLWB).  These benefits are not available with any other products, especially not those with lower fees.  You are paying for the assurance that your account will not lose value and will increase in value depending on market performance.  Annuities offer better returns than many products, especially CD’s offering less than 1% returns currently.  The best way to minimize your fees with variable annuities, or any annuities for that matter, is to only pay for the risk protection that is important to you.  Don’t add on protection that isn’t necessary and pay added fees.

The second argument that some people have against variable annuities is that they are taxed at the income tax rate rather than the capital gains tax rate, which is lower.  One thing to remember is that not all of your annuity payments are taxable, only the portion that is not a return of your capital.  Capital gains tax breaks are only given when stocks or mutual funds are held longer than a year.  This is quite often not the case, especially for day traders.  Many mutual funds have high turnover rates as well.  Even though on paper this tax difference seems like an issue, when you see the details it might not make any difference at all.

Finally, annuities are not given a stepped-up cost basis at death.  Stocks and mutual funds do offer this, but some stipulations are overlooked.  With mutual funds, investors pay taxes each year on fund distributions, even if your mutual fund loses value.  You often pay for a lot of the stepped-up cost basis through your own taxes anyways.  Annuities don’t get the stepped-up cost basis, but they also don’t get the stepped-down cost basis at death either.  Annuities that have guaranteed death benefits protect one’s heirs from losing money when the annuity holder dies.  This benefit overrides the other when you take into consideration all of the investments that lost money over the past five to ten years.  Variable annuities are definitely the right product for some people approaching retirement.  Take all of the pluses and minuses into account to see if the peace of mind you will get from their guaranteed income and investment will make an annuity right for you.

Written by Rachel Summit

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Fixed Annuities Provide Most Retirement Income When Future Markets Are Down

Life would be much easier for everyone if we had a crystal ball to see into the future.  Since we don’t, we need to be prepared for all possible scenarios in life, especially when it comes to planning for retirement.  Steve Vernon of CBS Moneywatch uses some helpful graphs to help us “Choose the best ways to generate retirement income.”  When you are figuring out how much income you will receive from your retirement savings, the current economic conditions should only be one of many things you look into. 

It’s important to see how your different options for generating retirement income will change based on good market conditions and bad market conditions as well.  So-called scenario planning is a good way to see how your income generator will work in both best and worst case situations, as well as everything in between.

In the first graph, made by Dr. Wade Pfau, six different retirement income strategies are evaluated in a negative economic future. 

The guaranteed income of the different annuity products performed the best when future economic conditions were negative.  Inflation-adjusted annuities provided the highest income after 30 years out of all six strategies researched.  They were followed by the immediate fixed income annuity, which provided the second highest income after 30 years.  Fixed annuities are not affected by market performance, so when markets decline, they certainly pay off as a good investment. 

Using constant systematic withdrawals, equivalent to the 4% rule, proved catastrophic in a negative economic environment.  Retirement income dropped to zero after 20 years and there was nothing left for the remaining 10 years that were studied, not to mention any additional years that you may actually live.

Both graphs use the same scenario to get their results: a 65 year old couple with $100,000 in retirement savings.  The second graph determines how your inflation-adjusted retirement income would change if economic conditions proved to be more favorable in the future than they are today.  In this scenario, you get the most income from strategies that invest your retirement income and pay you a percentage of that.

This makes sense, but are you willing to take the gamble on the markets being favorable right when you decide to retire?  Since the fixed annuities listed don’t change with the markets, they provided the least income of the studied methods when markets were up at retirement.  But their income was consistent in both graphs, something that provides peace of mind during retirement.

Behavioral science has shown that we as humans are more hurt by financial losses than we are pleased with unexpected financial gains.  What this and these graphs show us is that diversifying retirement income strategies may be the best way to protect and provide income in the future.  

Always be prepared with guaranteed income in case the scenario that you hope to happen is not the true life situation.  By assuming the worst and preparing for that with guaranteed income streams, you are protected either way.  If you want to use some of your retirement savings in the markets just in case the scenario is favorable, that could be a good option too.