Variable Annuities Explained

Hi, Matt Blocki with EWA. Today we are talking about variable annuities. And again, just like index annuities, in general, I recommend that clients stay away from variable annuities. So variable annuity is you’re putting money with an insurance company.

An insurance company has some contractual commitments to you, such as there could be a guaranteed level of income they provide regardless of what the market does. There could be a guaranteed minimum death benefit that’s available.

In general, when you put money into an annuity, you are in exchange paying a higher cost than a normal investment. But the company backing that up is paying you a paycheck or for as long as a joint annuity lives as well.

Typically, the fees and expenses of a variable annuity outweigh this cost. And if you just look at the complexity and what the actual fees are that are often not disclosed by an insurance agent, they’re obviously have to be disclosed in the prospectus.

The first fee is what’s called a mortality and expensivity. And just in general, we’ve analyzed a lot of these in the industry. This is generally around 1%. The company is taking this because there’s an expense for them to have the annuity on the books.

And they also don’t know how long they’re going to live. So out of all the group of annuitants they have on their books, some people are going to live too long. Some people are going to live too short. Some people are going to win.

Some people are going to lose. But they’re even at that risk by making sure that they have a fee that they’re taking out in the matter of love. The second thing is you do have control. And like a fixed annuity, you invest this money in an underlying index or an underlying fund that could be tied to the stock market.

And in general, these sub -accounts also have internal management fees, usually somewhere around 1%. First, these sub -accounts, a lot of the mutual funds that are offered them are proprietary. The company offering them is also sharing some of the revenue.

It would be very easy to replicate in a very well -diversified asset -aligned portfolio. Index funds, even some mutual funds for about a fifth of that cost. So any internal cost we’d like to see between 0 .2% and 0 .3%.

Generally, in variable annuities, we’ve seen the actual management fees of the funds itself to be three to five times what they should be. So that’s another red flag in our opinion. The third thing is rider fees.

And so usually the rider fees would be guaranteed minimum debt benefit for an income rider. And usually these riders are between 1% to 1% each. Out of all the annuities that we’ve analyzed, there’s been hundreds over the last 12 years of being in the financial services world, most variable annuities we’ve found have been between 3% to 4% when you add up all of the fees associated with it.

Now, this is often justified because the amount of fees with, oh, there’s guaranteed income, there’s these riders that are really important. In the reality, this is an extremely expensive way to invest in. You’re simply shifting your hard -earned money into the pocket of the insurance agent and also ultimately the pocket of the insurance company, which is charging you these fees not one time, but every year for the rest of your life.

Very complex products, but it’s very important to know in most of these products that there are two values that are completely different. There is an actual market value or surrender value. That’s if you just walk away from the thing, at any point that’s actually what you get.

And then there’s an annuity value. An annuity value is oftentimes what, you know, debt -benefited or an income stream would be based upon. But I just want to make it very clear that these fees are coming out of that market value.

And that market value is what gets passed on to beneficiaries. So whether that’s a kid, whether that’s a spouse. The market value gets affected by what the sub -accounts did, the ups and downs in the stock market. The market value gets affected by the stock market, by fees, and also by withdrawals.

So those three things, with the fees being so high, if you live to life expectancy, most of these contracts will be a very low balance by the time you pass. So it could be a OK tool as an income stream, but definitely is one of the worst tools we’ve seen that preserve and pass both on to the next generation.

And ultimately, when we run into annuities, they’ve been sold as… Here you can be a stock market investor, but also have some protection. be purchased if the intention is to actually take an income stream out of them.

Because at that point you can avoid some risk such as sequence of returns, but most of the time that we run into them, it’s more of a peace of mind factor that’s been sold and it’s not actually being used as an annuity is intended to use which is an income stream.

I just want to be very, very, very careful of that when analyzing. So the second thing is the annuity value and that’s what’s the what the income is based upon. Sometimes companies will offer a bonus value that comes in, but ultimately what’s going to get passed on is not an annuity value, it’s the actual market or surrender value of the contract itself, which as we see gets eaten up very quickly with these as well.

These are also usually very high -commission products. If it’s sold from a broker, there are some that if sold by a broker, it’s going to be very costly to unwind. Usually there’s a five to ten year surrender period that may just sample could be 8%, 7%, 6%, that’s the fee if you surrender within the first, second, third year that eventually that goes away.

The reason for that is there’s usually a big commission that’s paid out from these type of products. So the company is protecting themselves. They have to pay that commission to the insurance agent that sold the product. So if you walk away too quickly, they want to protect their pockets as well.

Are all variable annuities bad? No. In general, the landscape we think they’re oversold and most people, given their financial plans, if set up the right way, if set up with fail safes, if set up in a very fee sensitive, low cost structure diversified manner that you do better off without a variable annuity.

We welcome questions.