Variable vs. Index Products: Recommend The One Thats Best For The Situation
It is not uncommon to hear people in todays market expounding on the virtues of variable products over equity index products and vice versa. Often these proponents tend to take the position that a single product is the only solution to the customers financial needs.
Given that the past few years have seen significant growth in popularity of equity index products (the annuity version in particular), this seems a good time to compare and contrast the indexed and variable designs (does this sound like a college essay exam?).
The discussion will attempt to reinforce a premise that we have long heldnamely, “one size does not fit all.”
Equity index products are often characterized as a “simple” approach to retirement savings. That is, they enable purchasers to participate in stock market performance without the need to study investment theory, with no need for a professional advisor to monitor the investments (as is necessary with variable products), and with a great hedge against market downturns.
On the other hand, variable product proponents say no other type of insurance product provides the inherent flexibility to enable contract owners to shift investment orientation in order to protect against market fluctuations while still providing a degree of protection against disasters in the stock market.
The truth? In our view, there is a good argument for both types of products.
Variable products do provide the greatest ability of any investment product to shift investment orientations without the disadvantages of owning the underlying investments directly.
As anyone knows who has attempted to lock in market appreciation on mutual fund shares by redeeming shares to protect against a declining stock market, such an action can easily result in capital gains taxes. This is so, even though the funds resulting from the redemptions are reinvested into other, less volatile mutual funds.
In addition, many mutual fund investors over the past few years have had to pay capital gains taxes resulting from “phantom” gains from specific sales by the mutual funds of portfolio assets, even though the value of the entire mutual fund itself has decreased. Needless to say, mutual fund owners are not happy to have to pay taxes on assets that have diminished in value, especially when the value of the total investment is below the investors cost basis.
Variable insurance products, by contrast, are the only product we know that permits investors to change their investment mix, often to totally different types of investments, without any recognition of gain for tax purposes.
This investment flexibility is one of the most important features of variable insurance products. And, speaking to the topic here, such flexibility is generally not possible with equity index products.
With the equity index productat least with those currently availablethe index linking originally purchased is the one the policy owner keeps for the life of the contract. This is regardless of changed economic or market conditions.