Variable annuities with guaranteed lifetime benefits have become increasingly popular among clients planning for retirement income in recent years. However, like any other valuable product, these annuities come with a price tag that may make them impractical or undesirable for clients because of high fees that can easily exceed 3.5 percent of assets annually. These clients are not alone: Insurance carriers are also feeling the financial strain that comes from offering these costly products. As a result, many companies have begun to offer simplified versions of the traditional variable annuity with a lifetime income guarantee, with reduced fee structures. While clients may be relieved to see these lower sticker prices, it will often be up to the financial advisor to navigate the product features — and possible benefit tradeoffs — in this new sea of lower cost annuity options.
The problem with today’s variable annuities
The market turbulence of the past half-decade caused many clients who previously rejected the idea of tying their assets into low-risk annuity products to reevaluate their positions. The popularity of variable annuity products has soared in the intervening years. This has prompted many insurance carriers to develop highly specialized — and equally complicated — variable annuity products geared toward increasing the marketability of these products.
In today’s annuity world, the options are almost limitless: Clients can include riders to provide for long-term care, inflation protection, or life insurance-type death benefits, among others. This array of possibilities can make for a market in which many — if not most — clients have a difficult time understanding the benefits they are actually purchasing.
One of the more desirable annuity product features is the guaranteed lifetime income benefit. For many clients, these products represent a tradeoff because they offer relatively low returns in exchange for the promise of a guaranteed income stream for life. Importantly for some, these products allow the client to participate in the stock market without the same level of risk because the lifetime income stream is guaranteed.
This guarantee comes with a price tag that can increase the total annual annuity fee by over 1 percent, however, bringing the total annual fee to around 3.5 percent of the assets in the client’s account. Since the annual guaranteed returns on a variable annuity are low to begin with (at maybe 5 percent or 6 percent), it may be difficult for some clients to justify these fees. Further, even with these fees, today’s low interest rate environment has made it difficult for the insurance company to profit from products offering guaranteed living benefits.
A cost-effective simplification
In response to consumer confusion and reduced profitability, many major insurance carriers have begun to offer simplified versions of the variable annuity with lifetime income guarantee with annual lower fees closer to 2 percent of account asset value in some cases.
These products continue to guarantee an income payout each year for life, which is all that many clients really want in the first place. The company guarantees that the percentage payout will be based on the value of the assets that the client initially invests in the account, and no less. If the market performs well, the percentage may be based on the higher value of the appreciated assets.
This is where the underlying asset allocation becomes important — some insurance carriers allow the client to invest primarily in stocks (up to 80 percent in some cases), while others require closer to a 50-50 mix between stocks and bonds. Other carriers limit the client to a choice of several portfolio options — for example, the client must select one of three different portfolios of stocks and bonds chosen and managed by the carrier. While this professional guidance and simplification may be invaluable for some clients, others may prefer to exercise more control over their investment choice.
Some of these products also offer a deferral option that can allow the client to increase the eventual payout rate, meaning that the insurance company guarantees that the value upon which the payout is eventually based will rise by a certain amount in the years that the client waits before beginning the lifetime income stream.
In many cases, the only reason that a client is willing to consider an annuity product is because of one or more of the specific benefit choices that are now available. For many other clients, however, the maze of benefit options — and associated higher fees — deters them from entering the market at all. For these clients, a product with a guaranteed lifetime income stream at lower cost can be a perfect match.