Bank Investment Consultant

[Community Manager]

Why are variable annuities an attractive investment option?

[Lucullus]

A variable deferred annuity can be an attractive investment option in several scenarios. In general, I would say that they are attractive -

• Where the investment features (e.g.: dollar cost averaging from the fixed account to variable accounts in the first year, the ability to adjust the investment allocation at no fee and without triggering tax, a "stable" of widely diverse investment alternatives, offered (in many cases) by a variety of investment firms with differing styles and expertise, the opportunity for no-cost automatic rebalancing, etc.) and the insurance features (the minimum annuity payout rates guaranteed in the contract, a guaranteed minimum death benefit, and/or a guaranteed living benefit [if chosen]) are worth the costs.
  

But one can be more specific as to when a deferred VA can be attractive. For example,

• Where a client has both a low risk tolerance (i.e.: she cannot tolerate, emotionally, a great deal of volatility in the returns on, and the value of, her portfolio) and a low risk capacity (i.e.: the size of her portfolio, relative to the net present value of the income it must produce, is so low that it cannot survive, financially, those same effects of volatility), a variable deferred annuity with a "guaranteed living benefit" might permit her to allocate her portfolio more "aggressively" (so as to partake more of the "equity risk premium") than she would have been willing to do in the absence of that guarantee.
  
• For clients with modest IRAs, the total cost of a VA can be less than the cost of (a) access to the capital markets (via a mutual fund, ETF, etc.) plus (b) the cost of ongoing portfolio management and advice, even where a guaranteed living benefit or guaranteed death benefit is not needed or wanted. ( I suggest that most advisors will not be willing to charge someone with $50k IRA only 2.2% of AUM per year, including the cost of the underlying investments). Yes, Virginia. A VA can be a good deal for IRA money, despite what that blogger told you. In fact, it might be a better deal for IRA money than for non-IRA money. [see below].
  

One can also be specific as to a few scenarios in which a deferred VA is not likely to be attractive. For example -

• When the insurance features aren't desired. If guaranteed minimum annuity payout factors, guaranteed minimum death benefit, and guaranteed minimum value via future withdrawals are not wanted, a deferred variable annuity is probably a bad deal, because if you don't need insurance, you shouldn't have to pay for it.
  
  
• If the goal is the highest future after-tax lump sum value and the dollars are in a currently taxable account, a deferred VA will probably not perform as well as a mutual fund portfolio with the same asset allocation. The "all Ordinary Income" cost of tax deferral in the VA (not to mention the 72(q) penalty for early distributions) is simply too high a cost for the benefit of tax deferral. (This assumes current tax rates. If the spread between OI and LTCG rates narrows in future, the VA will look better, vis a vis the funds portfolio, than it does now).
  
• If you expect future your Ordinary Income tax rates to be higher than your current ones, stop here. Don't buy a VA.

These are just a few observations and reflect my own views and experience. They are Suggestions, not Commandments. And, as always, I could be wrong.

- John L. Olsen, CLU, ChFC, AEP