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The variable annuity: Has it lost its mojo?

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In 2007, it was easy to recommend a variable annuity to clients. You could offer the best of both worlds: upside potential and guarantee against loss.

“Mrs. Client, this variable annuity offers you a diversified investment portfolio with brand-name funds (subaccounts), tax deferral (a benefit only if used outside an IRA), and if the market declines, you’ll have an income guarantee that will allow you to take an income for life regardless of the performance of the subaccounts.”

Sound familiar?

While that story still holds true in many cases, reality proves it to be a bit more nuanced than that, given the changes seen in the markets since 2007. Are you selling variable annuities in the same way as you were in 2007, and if so, are you really comfortable with the story you’re telling?

Perhaps it’s time to get a bit clearer on where VAs fit and where they may have been supplanted by more focused products and strategies.

Before Registered Reps and BDs start firing off nasty emails, please keep reading. While I happen to operate an RIA and will only use a variable annuity that is fee-based, that doesn’t mean I’m on an anti-VA campaign. In fact, I find that many advisors should be more product agnostic than they are, acting as true fiduciaries for their clients, rather than product salespeople.

If a VA is the best tool for the job, so be it: Let’s agree to get clearer on which problem(s) variable annuities are best-suited to solve. I am first going to address some shortcomings that need to be addressed, and then discuss some of their best attributes.

THE BAD:

1. Cost

Yes, variable annuities have costs that place them in the crosshairs of those who are hungry to move the assets. While M&E fees, admin fees, rider fees, and many higher-cost subaccounts can add up total costs very quickly, the question to ask is: “Is the VA expensive as compared to…?”

2. Complexity

Receiving a 200+ page prospectus when you place your life savings into a product can cause drops of sweat to form on one’s brow. Not all VAs suffer from such complexity, but many do. But does complexity make something a poor choice? After all, how many people can repair a new Honda Accord themselves these days? They may be really complex, but still really good cars, right?

3. Lack of focus 

This is much more subtle than cost and complexity. If one product can allegedly provide three or four benefits simultaneously, can it actually be the best choice for any of those needs? For example, is it the best pure investment vehicle? Is it the best method to defer taxes? Is it the best way to provide lifetime income for a retired client? How can it be all things to all people and truly be the best at anything?

Now, in all fairness, any investment or product one chooses will have numerous drawbacks. Pick any one thing and it’s easy to pick it apart. While the VA is not inherently bad, in light of the above concerns, the question I encourage you to ask yourself in each situation is weather the variable annuity is a viable solution for each individual client you offer it to. This is especially relevant now, in this modern era, because there may be many other compelling choices available.

THE GOOD

Is there a good side to VAs? Yes! It is very viable, but it must be for the right person.  Who in particular? Well, the variable annuity can be the very best choice for the client who is looking for a Swiss Army Knife because they are not yet clear on what their adventure holds in store for them.

Let me explain it this way: If I were to send you into the woods and challenge you to survive for a week, with no knowledge of what’s in store for you, would you prefer a Swiss Army Knife or a chainsaw? I would think a Swiss Army Knife because of its many useful tools, all-in-one.

What if the game changed and you were challenged to enter the same woods and cut down the largest tree you could find, as quickly as possible? Would you prefer the knife or the chainsaw? I would imagine the chainsaw would be your choice.  Its best attribute, its specific purpose, is to cut down trees.

In the financial planning realm, where lack of clarity exists in the mind and plans of the client, the Swiss Army Knife, the variable annuity, may serve them better than other, more specific and focused, financial products and investments.  When the plan warrants a very specific need, the chainsaw is best.  For example, a retiring client with a very specific lifetime income need may be better suited with another form of guaranteed income annuity or a bond ladder than with a variable annuity that has other attributes, that cause the income benefits to be somewhat diluted, compromised.

Ultimately, the best use of a product is determined by the quality and focus of the planning we are able to do with and for each specific client. The better we can articulate the target goal, the more clearly we can articulate the product or investment choice. The variable annuity is a very powerful tool when used in the right circumstances. Used poorly, it can underperform and disappoint those it was intended to benefit, just the same as with any other financial product. Again, it’s all about choosing the right tool for the job.