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Top Story: What are the options for jittery variable annuity investors?

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“While it hurts to see an account balance go down or to sell [stock] when prices are low, at the end of the day, if the funds invested in a variable annuity are a material part of the nest egg, then clients need to take steps to insure they preserve what they have,” says Jeffrey Sharp.

A certified financial planner and principal for private client services and qualified plan investments at the SilverStone Group, Omaha, Neb., Sharp says that, “if it means reallocating to a more conservative portfolio, such as a bond or money market fund, then so be it.”

This bit from Sharp looks increasingly attractive among skittish investors who, concerned about today’s wildly fluctuating stock prices, earlier purchased a variable annuity without any of the guarantees that can protect invested assets against a market slide. For many, shifting into the more conservative portfolio of an annuity’s fixed account is appealing because it can backstop investors against further losses.

But sources tell Annuity Sales Buzz that more risk-tolerant investors would do well to consider other approaches. Among them: diversifying into alternative vehicles available within the subaccounts of certain VAs, such commodities, real estate investment trusts and hedge funds; spreading retirement funds among several annuities through a laddering strategy; or purchasing a rider that systematically increases equity exposure when markets recover.

As for moving assets into a fixed account, Sharp himself is quick to point out that this approach is not without risk. Whereas equity investments are subject to market fluctuations, the insurer’s ability to make good on a “guaranteed” interest crediting rate offered on a fixed account–and even to assure that funds invested will ultimately be paid out–depends on the carrier’s financial stability, he notes. The reason: fixed accounts are backed by the insurer’s general assets.

Sharp recalls that when the New Jersey Department of Banking and Insurance placed the now-defunct Mutual Benefit Life Insurance Company into rehabilitation in July 1991, individuals who held funds in variable subaccounts were able to liquidate these assets in short order. But holders of the insurer’s fixed accounts had to wait many years to receive all of their invested assets.

Therefore, when contemplating such a move, producers and clients should investigate the insurer’s financial strength, and in particular the carrier’s credit rating with the major credit rating agencies, says Sharp.

They should also read the contractual rights stipulated in annuity contracts, he indicates. A carrier may, for example, reserve the right to limit the distribution of funds from a fixed account to 20% of the account value per year; or to hold the money for 6 months before distributing.

“Clients need to understand the potential constraints associated with the fixed account,” says Sharp. “To the extent there may be a concern about the company’s financial stability, they also need to ferret this information out before shifting assets from a variable to a fixed account.”

While moving funds from variable to fixed accounts may be the priority of some investors near-term, the question for many in the mid-term is when to move back into equities so they can take advantage of a future market upturn. Though it is difficult to time the market, advisors note that many clients would do well to leverage VA features that automatically increase equity exposure over time.

Case in point: Prudential Annuities’ Lifetime 7 Guarantee VA protects investors’ account values when markets perform poorly and systematically reinvest funds in equities when stock values rise. Via its guaranteed minimum withdrawal benefit rider, the annuity locks in the highest daily account value and yields a guaranteed 7% compounded annual growth rate until the client elects to annuitize.

“As markets recover, assets will shift back into an asset allocation portfolio that the investor and his or her financial advisor had chosen,” says Bryan Pinsky, a vice president of product development and actuary at Prudential Financial, Newark, N.J. “So the investor doesn’t have to try to time the market.”

“Too often,” Pinsky says, “clients fall prey to the emotions most commonly associated with investing: greed, fear and regret. This is the greed of wanting to have as much upside as possible, the regret of not being able to sell at the market high, and the fear of losing more than they’ve already lost in the market. As a result, they end up selling low and buying high.”

Thomas Hamlin, a producer and branch manager at Raymond James Financial Services, St. Petersburg, Fla., points to a Value product from Cincinnati-based Ohio National Financial Services. Assuming a starting investment of $100,000, this VA can, for example, reallocate one-sixth of the total every 30 days into any of 65 available options, such as a total return fund, a money market fund or a more diversified asset allocation portfolio.

Those clients who aren’t comfortable placing their nest eggs in such standard investments as bonds and mutual funds can find vehicles that, in years past, were chiefly available only to the most affluent investors. As an example, Pinsky says that Prudential recently launched an Academic Strategies Asset Allocation Portfolio which has such options as private equity funds, commodities, REITs and hedge funds.

What other strategies are available to the skittish client who is looking to mitigate risk in the current market environment? Adopt an annuity laddering strategy, suggest several executives.

Rather than placing, say, $300,000 in a single variable annuity, the client could invest $100,000 in each of 3 annuities that would annuitize at different times during retirement and that would carry a different investment mix. Typically, the 1st annuity would begin distributions within the 1st years of retirement and be invested in a conservative portfolio of bonds and equities. The 2nd and 3rd annuities would pay out from years 5 to 10 and 10 to 15, respectively, during the retirement phase and contain progressively more aggressive investment allocations.

However, Sharp says this strategy is more appropriate for new investors than for those who already own a VA. Under IRS rules governing 1035 exchanges, he explains, individuals may replace one annuity with another without incurring a tax penalty. But substituting multiple annuities for a single VA will result in payment of ordinary income tax.

Hamlin notes that a laddering approach must in all cases divvy up the contracts to be purchased among different manufacturers. Should a client buy, say, 4 policies with the same company, the IRS would treat the amounts invested as a single (or serial) annuity, aggregating the various account values and disqualifying tax-favored treatment of the transaction.

Ultimately, adds Hamlin, VA holders will have to factor the number of years they have until retirement–as well as the prospect of living 20 years or more once they retire–when deciding on an approach to mitigating market risk in today’s uncertain times.

For many still young boomers, he indicates, some exposure to equities is necessary. But boomers should always purchase a guaranteed living benefit and/or death benefit rider to lessen the risk associated with such exposure, he emphasizes.

“To me, it’s irresponsible to not have such safety net guarantees,” says Hamlin. “This is like buying a car that has great brakes and a big motor, but comes with no air bags or seat belts. At end of the day, these guarantees are needed to protect assets against a market downturn and to give clients the peace of mind and confidence needed to invest more aggressively than they might otherwise.”


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