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Variable annuities and the lifetime income challenge

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Almost every study produced shows more and more consumers are interested in guaranteed lifetime income benefits. It has caused many advisors who were previously opposed to them to get educated and catch up to those of us who were ahead of the curve in providing the very best for our clients.

However, many variable annuity (VA) providers are changing their plans. These changes are taking place in existing and new product offerings. These lifetime income benefits as well as guaranteed death benefits are becoming very expensive for insurers due in part to the extended low-interest-rate environment.

Insurers are actually asking policy owners to give up those benefits of their own free will. Some are even giving owners cash incentives in their current annuity. Some insurers further plan to minimize the distribution network and VA offerings.

Others are no longer going to offer variable annuities at all or are giving their sales force minimal notice, sometimes just days, that plans are changing or no longer being offered.

There are two risks that VAs present: the longevity of policy owners and exposure to the market.

Getting creative

Variable annuities are still selling at a record pace as insurers get creative with their scaling back of the benefits. The fees for living income and guaranteed death benefit riders range from 0.75 percent to 1.25 percent. Insurers are limiting benefits at the same cost so as not to produce sticker shock. Some analysts have compared it to what food manufacturers do when costs of production go up. We go and buy a bag of chips for 99 cents and come back a few weeks later and find a smaller bag is in its place for the same price.

Further, some insurers are launching variable annuities without these benefits and increasing their sub-account offerings. This is important since many insurers limit the type of allocations an owner can participate in if they have a living or death benefit. This limiting of sub-accounts (most often mutual funds) helps protect the insurer from large decreases in the cash value.

Consumer interest growing

The increase in consumer interest in VAs is due in part to the recent volatility in the market. In my opinion two other factors are the insecurity many have because they don’t have a company-sponsored pension. The other is the media attention surrounding the stability or instability of Social Security.

This is causing many consumers to opt for paying a fee to guarantee they have a steady cash flow of supplemental income through their retirement and if necessary, a spouse’s retirement as well. Some advisors push their clients to avoid these types of plans in part due to the annual fees and also in part because of their world view that averaging a percentage means they can safely withdraw a percentage. In my opinion this approach leaves the client at risk of running out of assets. This fatal approach is called compounding in reverse.

In some cases advisors are encouraging their clients to ignore these plans despite their unsolicited request for education on these products. As fiduciary advisors, our job is to not only offer plans that best fit our clients’ needs, but also to be educated ahead of our clients in order to best serve them. Recent studies have shown consumers are increasing their online searches of these instruments by astronomical numbers; this is going to leave many advisors in the dark ages.

An additional argument advisors use to encourage their clients not to pursue guaranteed lifetime income plans is the idea that it takes too long for a client to get their principal back. For some advisors the time commitment, which can be up to 20 years, is too long of a time frame for their clients. Thorough education on the advisors’ part, as well as the ability to offer any and all plans to their clients, allows them to design plans specific to the client’s situation.

Once again this financial malpractice comes from a faulty philosophy — the idea that 20 years (if that were the real number) is to long for clients to wait to get their principal back, yet all the while having a steady flow of income and their principal protected from stock market losses.

If we look back at the past 12 years, people have had to wait a long time to get their principal back. Plus, during that time, they had to ride the ups and downs of the market, both financially and emotionally. If they were taking income from that same portfolio, many would be fearful of running out of money, not just getting their principal back.

On the flip side, many advisors recommend not taking an income annuity because a client may have to wait 15 or 20 years to get their money back. In the worst case, they would just see their money returned to them safely without riding the ups and downs of the market. As an income planner who’s more worried that my clients get the return of their money rather than the return on their money, I often will incorporate this type of plan somewhere in my clients’ portfolios.

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