Jefferson National White Paper Says Variable Annuities Offer 'Tax-Efficient Frontier'

A recent Jefferson National Life Insurance white paper on portfolio management says that tax efficiency will emerge as a “significant new imperative” as taxes rise and markets remain volatile and that financial advisors can mitigate clients’ risk by investing in a new category of low-cost variable annuity.

Titled “The Tax-Efficient Frontier,” the paper written by Jefferson Chief Operating Officer David Lau asserts that certain asset classes benefit considerably from tax deferral while others don’t. By adding the principle of asset location on top of asset allocation, Lau claims, advisors investing in a new category of variable annuity can help clients earn higher returns without taking on any additional risk and increase after-tax returns by as much as 100 basis points.

The white paper states that locating asset classes in the right vehicle, whether tax-deferred or taxable, can increase internal rate of return without increasing risk. Because U.S. tax rates have been so low in recent years, achieving a “tax-efficient frontier” has not been a priority for many advisors, according to Lau. But, he adds, this is likely to change now that the Bush tax cuts are ready to sunset and tax rates are moving back up.

“Now,” Lau writes, “there is a new category of low-cost no-load variable annuities that can be used as wrap products, allowing clients to invest more tax-deferred. An analysis suggests the use of these VAs can increase an investor’s long-term wealth by approximately 100 basis points per year without increasing risk.”

Variable annuities have become more popular in recent years because they allow holders either to take a lump sum upon retirement or to create a steady income stream that can last for years or until death. But these annuities also have drawn criticism because of the stiff penalties charged–of 5% or more–if investors want to withdraw money earlier than scheduled. A January 16, 2006, online Wall Street Journal report on the issue points to the efforts of companies like Jefferson National Life Insurance to overcome this negative image by selling variable annuities with lower costs.

In the paper’s key points, Lau says that to optimize the tax-efficient frontier, affluent investors may need access to more tax deferral than allowed by the low contribution limits of 401(k) plans or IRAs. However, he says, the only real alternative–the variability annuity–presents numerous challenges, starting with “fee bloat,” which typically destroys the benefits of tax deferral.