Are lower cost variable annuities with lifetime benefits a bargain?

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