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July 31, 2007 at 08:00 PM
It’s not hard to find bad press about variable deferred annuity contracts. It’s quite possible that your clients have heard negative things about these types of investments. Typically, opponents cite high fees and low liquidity as reasons to stay away from these contracts. But when used properly, variable deferred annuities can be a valuable part of a client’s retirement plan.
Following are 10 common objections to variable deferred annuities and how to beat them.
Objection #1: Fixed income investments are safer
On the most basic level, a variable deferred annuity is a contract between the client and an insurer that is intended to be held over the long term for the purpose of generating a reliable retirement income. As a rule, the most basic contracts provide for a return of the original investment, less charges and withdrawals. Many offer enhanced benefits for additional fees. Although variable deferred annuities are not FDIC insured, their guarantees are based on the claims-paying ability of the issuing insurer. Unlike fixed-income investments, variable deferred annuities allow the client to invest in both equity and fixed income markets through a variety of sub-account selections. Furthermore, variable deferred annuities offer a death benefit component, either standard or enhanced, that may be unavailable from fixed income investments; however, these benefits may be offered for additional fees that are not included in fixed income investments.
Objection #2: The tax advantages of a variable annuity are insignificant
One of the most notable variable deferred annuity advantages is tax-deferred accumulation. When properly structured, the owner may delay paying tax on gains until a future date, usually when the owner begins taking payments. This may offer an advantage by offsetting the effect that immediate taxation may have on the growth of the investment.
There are three main tax differences between mutual funds and variable deferred annuities:
1. Under the proper circumstances, mutual fund gains may be treated and taxed as capital gains, while variable deferred annuity gains enjoy tax deferral until they are withdrawn, at which point they are treated as ordinary income. (Mutual funds purchased in a retirement account, IRA, 401(k), etc. also experience tax deferred growth and will be taxed as ordinary income when withdrawn.)
2. Mutual fund losses may be tax deductible; variable deferred annuity losses may not be.
3. If a client has a taxable mutual fund and wants to sell shares of one account and buy shares of another, this is a taxable event. However, with a variable deferred annuity, owners can exchange shares tax-free across all sub-accounts, thereby encouraging efficient rebalancing in accordance with their investment profiles or changes in risk tolerance.
Objection #3: There’s no step up in cost basis
When tax-deferred assets pass to beneficiaries upon the death of the contract holder, taxes due on the earnings can erode the inheritance. A concept called “stretching” allows beneficiaries to withdraw payments from a qualified account or non-qualified annuity over time, rather than taking a lump-sum distribution. Plus, variable deferred annuities do not have a step down in cost basis either, meaning the annuity can be guaranteed through a down market during the owner’s life as well as once it is passed on to the beneficiary.
Objection #4: You have to annuitize to receive benefits
No, you don’t — at least not until the contract’s maturity date. A variable deferred annuity can still be a worthwhile investment even if the owner chooses not to annuitize.
If elected at the time of the contract’s inception, optional living benefits can be advantageous throughout the owner’s life. Enhanced death benefits can also provide security to the beneficiary. Various annuity riders can be purchased that, if properly structured, will provide both income protection and death benefit protection for the annuity owner and their beneficiaries.
Objection #5: Variable annuities force you to give up liquidity
Money that is invested in a variable deferred annuity should not be viewed as illiquid.
Variable deferred annuities are designed to help retirement-minded investors capitalize on tax-deferred growth over the long term. As such, they are intended for people who can invest an amount of money and leave it to work for them for at least a decade. Typically, surrender charges are levied if the contract is terminated during the early years. While variable deferred annuity contracts should not be viewed as liquid assets, they can provide, and are intended to provide, income to the owner during the owner’s life.
Objection #6: Annuities lack investment options
Variable deferred annuities offer a diverse collection of sub-account choices; options include asset allocation portfolios as well as multiple asset classes. The underlying funds are generally managed by third-party investment firms. Some are household names you’re sure to recognize, while others are better known among institutional investors.
