The market collapse of 2008 impacted every player in the financial services industry, putting pressure on all companies to reform their product offerings. Specifically, in the variable annuity industry, companies could no longer guarantee the same withdrawal rates and benefits as they had in the past.
Confronted with historic low rates in the fixed income market, providers were forced to reduce liability from their balance sheet and to modify guaranteed products. Their solution has been to reprice and retool these guarantees, raising the costs and significantly reducing the benefits offered to consumers. At the same time, some insurers have been eager to remove this liability from their balance sheets altogether. In a decision that has proven quite controversial, a handful of providers have chosen to renegotiate legacy products, attempting to buy out policyholders from their existing guarantees.
In a more recent trend, others in the VA industry have turned to asset managers as a way to fill in this gap. There are now a growing number of funds designed to provide downside protection and generate predictable income using hedging strategies and other approaches similar to what insurers use to manage risk on their own balance sheets. These new funds provide investment opportunities that can replicate the benefits offered by riders, but with lower fees and much greater flexibility.
The value of tax-advantaged investing
As a result of these shifts, today’s variable annuity landscape is markedly different from the one we faced before 2008, and it’s critical that advisors and their clients understand how to navigate these changes to ensure the best outcomes.
Given today’s ongoing volatility, uncertain fixed income market and rising tax environment, tax-advantaged investing has become increasingly important. For advisors, utilizing a tax-deferred vehicle such as a low-cost, no-load variable annuity is a proven solution to optimize the performance of their clients’ portfolios. In fact, research has shown that tax deferral has the potential to increase returns by an average of 100 bps or more — without any subsequent increase in risk.
Low-cost VAs allows clients to maximize accumulation and to generate more retirement income, while also mitigating the impact of high tax rates. Low-cost tax deferral is also a proven solution to provide more value to all clients — and especially to the high net worth, who typically have the highest tax burden. At the same time, these low cost, no-load VAs are the perfect fit to meet the unique needs of today’s growing number of RIAs and fee-based advisors, as well as those who are transitioning to a fee based model.
Optimizing variable annuities
The following are three key components for advisors to consider when using tax-deferred vehicles:
- Consider the cost: The option for tax deferral must be low cost. Given research has shown that tax deferral has the potential to increase performance by 100 to 200 bps, then the lower the cost of access to tax deferral, the more benefit a client will receive.
- Demand choice: The ideal tax-deferred vehicle should contain a wide variety of fund choices. This will allow advisors to manage assets within a portfolio with the right investment strategy to optimize returns and manage risk in order to meet each client’s unique risk profile and income needs.
- Locate assets to maximize tax-efficiency: Asset location is crucial to increase returns without increasing risk. To maximize accumulation and to generate more retirement income, advisors should wrap tax-inefficient investments — including fixed income, REITs, commodities, liquid alternatives and small-caps — in tax-deferred vehicles. Funds or portfolios that are tactically managed or have a high turnover rate, generating more short term capital gains, are proven to benefit from adopting tax-deferred strategies.
The future of variable annuities
As more advisors and brokers move to a fee-based approach to serving their clients, no-load tax-deferred vehicles have become increasingly important. Optimizing clients’ portfolios by leveraging tax deferral is a valuable solution to maximize accumulation and generate more income. Moreover, as rising taxes remain a top concern among clients, advisors can mitigate the impact and provide more value by using this next-generation of variable annuities.