At Jefferson National, we’ve been following for years the polarizing debate around whether variable annuities are a key part of retirement planning or the worst of all possible investment vehicles. To say the least, the question has been treated as a black and white issue.

Recently, the question gained further steam with the recent publication of a Q&A with Fisher Investments CEO Ken Fisher essentially saying that he “hates annuities” — especially variable annuities — because they are a “Ponzi scheme,” sold on “lies” that are “too good to be true.” A rebuttal quickly followed, quoting industry experts, including Dr. Wade Pfau, Dr. Moshe Milevsky and others, which took the counter position that annuities, especially immediate annuities, can be “a very important retirement tool.” So what does this all mean? To cite a rather famous Clint Eastwood movie, are annuities the good, the bad or the ugly?

We come down squarely on the side of ugly — but mostly in terms of perception. Ugly because the virtues of variable annuities are often masked behind layers of asset-based fees, complexity and lack of transparency.

To get past the ugly and beyond the question of good versus bad, it’s essential to start with the consumer and their advisor. For whether a variable annuity is good or bad depends on the unique financial profile of the client and their level of risk tolerance. And, it’s the advisors’ job to help sort through the available products to look for transparency, low cost and client value. 

Annuities 101

So let’s review the basic categories of variable annuities and set some guidelines around how they might properly fit into a client’s portfolio. While similar in their end goal, variable annuities come in different varieties, each one unique in meeting different needs for different clients. Most relevant to the recent debate, are these three:

  • Immediate Annuities. Also known as income annuities or single premium immediate annuities (SPIAs). These annuities generate income by pooling the mortality risk across a large group. In some ways, they behave like private pensions, providing a guaranteed, predictable income for a set period of time or until the death of the annuitant. Immediate annuities are best suited for risk-averse clients with longer than average anticipated life expectancy. What a client and advisor lose is the ability to manage the underlying investments, while facing the risk that they do not live long enough to realize the long-term value of the annuitization.
  • Deferred Annuities. Deferred variable annuities offer the option of annuitization but are primarily used to invest tax deferred in underlying sub accounts. The vast majority offer insurance guarantees, such as living benefits, to protect both principal and future withdrawal capacity. VAs with guarantees are often best for clients who are more risk averse, more pessimistic about market performance (especially if they have shorter investment time horizons) and less concerned with leaving a financial legacy. Advisors should be conscious of fees, as they can sharply impact returns and erode the power of tax deferral, and be aware that many guarantees require limited investment options. In addition, low yields and ongoing volatility have made guarantees more costly for insurers to manage — and more expensive for consumers to purchase.

  • Investment-Only Variable Annuities (IOVAs). This is a new generation of variable annuity, re-engineered to maximize the power of tax deferral through low costs, no commissions and more underlying funds. Low-cost IOVAs can be used as a tax-advantaged investing platform to accumulate more wealth before retirement and continue accumulating wealth during retirement. IOVAs do not offer insurance guarantees, which for many advisors is an advantage, as they want to manage the underlying sub accounts themselves to generate the necessary retirement income for their clients. To this point, a whitepaper by Pfau, based on running 5,000 Monte Carlo simulations for a variety of investor scenarios (using more than eight decades of market data) showed that low-cost IOVAs are likely to generate income comparable to deferred annuities with guarantees, with more upside potential and a larger ending balance. IOVAs are often best suited to clients who want more investment flexibility, expect spending in retirement to keep pace with inflation and want to generate retirement income as well as leave a financial legacy. 

While Fisher is right that certain types of annuities can rack up fees that erode returns and diminish wealth, as Pfau and Milevsky point out, lumping all annuities together does an injustice to the industry. Annuities can be a valuable tool, offering unique characteristics that other retirement products don’t.

To dismiss them en masse is to miss the point. Ugly can indeed turn to good. Come to think of it, Milevsky was right: annuities could certainly use a rebranding.