From the February 2011 issue of Research Magazine • Subscribe!

February 1, 2011

Do the Math: A 1035 Exchange Can Pay Off

As the first boomers turn 65 this year, and 76 million more approach retirement over the next two decades, two critical issues are on the minds of advisors and clients alike: The urgent need to save more for retirement — and the fear of outliving retirement income. Thus, low cost/no-load variable annuities can be the right fit in a tough market where every basis point counts.

Retirement: A Moving Target

Retirement ground rules used to be simple: Stay with a company, retire at 65, collect a pension and Social Security. But as pension plans decline and Social Security’s future is unknown, preparing for retirement — and surviving it — has become a moving target. Americans are living longer and those extra decades in retirement raise the stakes. How much money should clients save — and how much can they spend — to ensure their savings will last a lifetime?

There’s no doubt accumulation is key. Most experts agree, the more clients can accumulate, the more retirement income they can generate. And few things beat tax-deferral. After maxing out 401(k)s and IRAs, that means looking at a new category of low-cost/no-load variable annuities to tap into additional tax-deferral and unlock the potential for greater performance.

The Low-Cost Solution

Finding a solution to unlock the value of underperforming VAs has always been a challenge. The problem goes beyond asset-based insurance fees, commissions and surrender charges that can lock in clients for decades. “You’d be surprised how many clients don’t really know what they’re paying for in a VA,” said Aaron Grey, director of operations of Denver Money Manager. “They get into the product with no investment advice and almost no investment options to choose from. And the next time they look — they’re barely posting a return.”

The costs of traditional VAs can quickly escalate. With M&E averaging 1.35 percent of invested assets according to Morningstar, $100,000 in a traditional VA can cost your client $1,350 per year in basic insurance fees alone. And a $1 million VA can cost $13,500 or more — every year. Add on death benefits and the latest living benefits and costs easily double. But many low-cost/no-load VAs charge as little as 45 to 65 bps per year. And a new category of VA charges a flat-insurance fee of $20 per month — just $240 per year — no matter how much clients invest.

The Right Fit for High-Net-Worth

Grey has used a tax-free 1035 exchange to successfully transition many high-priced VAs into low-cost/no-load products, including a flat-insurance fee VA. “With no asset-based M&E, no administrative fees, no load and no surrender charges, just do the math — the flat fee starts making sense. It’s a great fit for high-net-worth clients, and can work for almost anyone who is currently in a VA and paying too much.”

Brian Schreiner, vice president of  Exton, Pa.-based Schreiner Capital Management, a money manager serving financial professionals, works with many advisors whose high-net-worth clients quickly surpass the low contribution limits of qualified plans. “That’s the ideal client for an exchange into a low-cost annuity,” he says. “They appreciate the benefits of tax deferral — and the substantial savings in fees. They don’t need riders — they need the tax shelter. They want their income to compound and grow.” Schreiner adds, “By exchanging into a low-cost VA with a broad range of funds, investors can save thousands each year, and we can manage their assets in a way that seeks  to maximize performance — and minimize risk.”

The Living Benefits Battle

When clients shift from accumulation to income distribution, the fear factor hits new heights. And that helps sell living benefits: Nearly eight in 10 VAs are sold with these riders according to the Insured Retirement Institute. But is it worth paying such a high cost for the next “sure thing” — especially when the income may not be needed for years — or decades? Many advisors and experts say a well-diversified portfolio and well-structured financial plan can yield just as much as living benefits.

"People buy living benefits out of fear,” says Schreiner. “But the cost equation can actually hinder a client’s ability to generate lifetime income. And living benefits can never make up for money you haven’t saved.” For clients seeking lifelong income, Schreiner emphasizes long-term accumulation. “A 1035 exchange into a low-cost VA is helping many investors save on fees and accumulate more, so they can reach their goals faster.”

Help Your Clients Reach Their Goals Faster

You can help clients by assessing the pros and cons. Excessive fees may be eroding their growth potential. A lack of fund choices may limit their investment performance. But not all riders are excessive. And not all contracts are suitable for exchange. You’ll need to run a cost-benefit analysis. Important items to consider include:

  1. Match product to goals — Why was the original VA purchased? If your clients are not sure, if they have second thoughts, or believe they were pressured, take a step back, redefine needs and consider an exchange.
  2. Compare features to needs — Do your clients understand all the features and guarantees? Are they determined to pay for “peace of mind”? Are their guarantees “in the money”? Then an exchange may not be an option. But if you can offer another solution to manage risk and still save more, then an exchange may be appropriate.
  3. Assess all fees — Track and compare every fee: M&E, administration, maintenance, death benefits, living benefits, additional insurance guarantees, surrender charges and fund expenses. And if these fees are asset-based, the more a client invests, the more they will pay.
  4. Determine the contract’s age — Many contracts impose surrender charges for the first five to eight years after the original purchase, making it costly to switch. But if the new VA is low-cost, your client may save enough on fees in the first or second year to break even and justify an exchange.
  5. Review investment selection — What is your professional assessment of the fund selection? Are all asset classes represented? Is it sufficient for your management strategy? Are there a range of different money managers — or mostly proprietary funds?
  6. Check performance after fees — Do the investment statements reflect respectable returns, or sub-par performance? Now, factor in fees. Is the client still ahead, or barely hanging on?
  7. Account Management Capabilities — Your clients may benefit most from your oversight if the VA has a technology platform that lets you create custom allocations, perform mass transactions and trade online. Does their current VA offer these capabilities?

No single product can meet all your clients’ needs. But when accumulation is the goal, the right VA can be the right fit for almost every portfolio. Now that innovative annuities can offer an efficient tax-deferred investing vehicle — instead of a costly insurance contract — an exchange to a low-cost/no-load VA can help clients build a healthy nest egg for the long haul instead of a big goose egg.

To learn how clients may benefit from exchanging an overpriced VA, visit the Annuity Comparison Calculator (https://advisor.jeffnat.com/comparison/) to see how much they can save and how much more their savings can grow, using the most up-to-date Morningstar data to compare nearly 1,000 different products from more than 100 different companies, as well as a FINRA-approved proposal generating tool.

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