Sales of traditional variable annuities may be down (perhaps even falling) because of market turmoil in recent years, but there is at least one type of variable annuity product that is actually gaining steam—investment-only variable annuities (IOVAs). Despite their lack of traditional guarantees, the lower price tags and unique investment potential associated with IOVAs have led to sales figures that have been steadily climbing.
Today, insurance carriers that offer IOVAs may have come up with a way to appeal to an even greater range of clients—by offering to tack on one of several optional death benefit features to provide another layer of protection.
IOVAs: The Basics
IOVAs are a subset of variable annuity that are, as the name suggests, focused on the investment potential of a tax-deferred annuity product. While these products offer the same tax-deferral benefits as a traditional annuity product, they do not offer the lifetime guarantee features that have come to be associated with annuities.
Because of this, the fees that a client must pay to maintain an IOVA are much less than those applicable to other types of annuities. Studies have shown that this allows for more robust investment growth, as the high fees that are associated with guaranteed variable annuities (which can exceed 2% or 3% each year) can erode returns and increase the risk of wealth depletion in the long run.
IOVAs offer a wide range of investment options, including both conventional investment portfolios and some that are not widely available to average clients—often, “alternative” investments, such as real estate, commodities and hedge fund options. Although there are no traditional guarantees, the use of such a wide range of investment options theoretically allows an IOVA to offer downside protection through the use of hedging strategies and diversification.
The IOVA Death Benefit
Despite the investment potential to be found with IOVAs, many firms find the products to be unsuitable for clients looking to purchase one with funds that are already in a retirement account. In addition to conventional legacy planning, this may be one of the reasons that firms have begun to offer optional death benefits as add-ons to IOVA products.
While most IOVAs offer a standard death benefit (a return of account value), optional additional death benefits have manifested in several different forms, including a popular return of premium benefit that offers a lower-cost option. Other carriers offer guaranteed minimum death benefits at a slightly higher cost (typically, the optional death benefit cost is a percentage of account value and depends upon the client’s age).
Another option that has emerged is a death benefit that provides a “highest anniversary” death benefit that will either pay out the contract value, contributions to the contract or the highest account value on any contract anniversary (whichever amount is highest).
Many carriers will only offer the option of purchasing additional death benefits when the contract is issued (although the benefits can usually be cancelled at any time). Further, optional death benefits are typically only available to clients who are age 85 and younger when the contract is issued.
For older clients, however, the IOVA option may not be suitable, as the account value will likely not have sufficient time to grow during the client’s lifetime—eliminating the primary benefit of an IOVA.
While IOVAs may not be suitable for all clients, for those attracted to variable annuities because of the investment potential, the IOVA can provide an alternative solution that may even surpass variable annuities in their capacity to provide strong returns.
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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