Flying Low

Jacob Herschler, vice president of variable annuity marketing for American Skandia, which has decided to focus its efforts on VA sales and mutual funds, extols the virtues of its new products. He is particularly voluble about the GROW, or guaranteed return, option that can be had for 125 bps per year and enables the annuity holder to lock in market gains or to ensure that principal will not be lost. If an annuity is purchased with the GROW option, it locks in the basic value of the account (say $100,000) for seven years. The account is reviewed nightly by a computer model that may transfer funds from the account’s equity holdings into fixed holdings to ensure that the account’s long-term value will not drop below the original figure of $100,000 by the end of the seven-year term. Since one clear industry trend is visible in the flight to guarantees, the GROW option will no doubt be popular.

There has been much criticism of VAs in the past, in our pages and in numerous other places. But there is a time and a place for everything, and VAs have a definite champion in advisor Femi Shote of Asset Harvest Group in South Waltham, Massachusetts. Says Shote, “If I say I love VAs, it’s like someone saying, ‘I love minivans.’ Of course I’m going to love minivans if I have kids.” He goes on to point out that VAs “do one thing: they provide an income stream.”

Shote says that people use VAs for the wrong reasons. “They use them to help people accumulate money,” he says. “I use them to distribute money. That was the real reason they were designed. A mutual fund cannot do a job that an annuity can do. I don’t use annuities as a wealth transfer vehicle, either. Again, that’s like buying a minivan when what you need is a four-door sedan.” Shote is firm on the subject. “I’m very particular about how I use them.”

Shote says that VAs are overrecommended, and inappropriately recommended. As he explains it, “The vehicle itself says, ‘I’m going to give you X amount of money for the next 20 years, or 30 years, or the rest of your life.’ As a variable annuity, it will vary, but there is always a stream of money that comes. I’m focusing on the vehicle itself, not the investments. There is a floor. The annuity says, for instance, ‘Give me a million dollars and I’ll give you a minimum of $35,000 a year for the rest of your life. That number will always come. It could be more if the subaccounts you pick perform better. If the market continues to perform on an aggregate basis and goes up, instead of $35,000, I may give you $40,000 or even $50,000 but you will always get that minimum of $35,000.’” He uses VAs, he stresses, for core client income needs.

VAs have a bad name, he feels, because they have been overpromoted. He cites the movie Get Shorty as an example, in which Danny DeVito, playing a movie star, saw John Travolta, a “cool Mafia dude,” driving a minivan. He didn’t know that Travolta had been given the minivan because the car rental company at the airport didn’t have the Cadillac Travolta had requested. They gave him the minivan, telling him that “it was the Cadillac of minivans.” So DeVito, seeing Travolta driving the minivan, goes out and buys one himself. And then other people, seeing DeVito driving a minivan, go out and buy minivans. Says Shote pointedly, “Maybe they should have been driving sports cars.”

Fees are important, he reminds us, and he likes the new products. “The insurance companies and investment companies have been more responsive,” he says. “They’re designing annuities that are skeletal. You build what you want into it. In the old days, they were all loaded; M&E and all built in. Now there are products where there is an engine, and you pick and choose the options that you want. I pick the kinds of things I want in it.”

Cassaday disagrees with Shote about wealth accumulation; that’s one of the ways Cassaday uses VAs. He finds them useful “if you’ve got someone who wants to invest systematically,” he says. “The problem is that if you put money over a long period of time into a mutual fund or a drip plan, tax basis accounting for that is very difficult.” Cassaday says he sees this often in his practice: “A relatively wealthy client with five little accumulation accounts, where he puts fifty bucks a month in each of them.” With VAs, Cassaday points out, “you can put a hundred dollars each into five funds and get one statement with everything on it. No 1099s; the cost basis is taken care of by the annuity company. It’s very straightforward; what you put in is your basis, and the rest is your gain.”

Cassaday also believes that putting VAs into retirement plans is not necessarily a bad thing. “There’s no cost for tax deferral,” he says, and points out that an annuity in a non-tax-deferred account has “no step-up in basis. Everything in the annuity is taxable. With an annuity in a non-qualified account, you don’t get the step-up in basis and every dollar will be taxed as ordinary income to someone; there’s no capital gains rate, no long-term rate.” Advisors, he says, should keep an open mind.