One fundamental conclusion: Just as the power of tax-deferred compounding can grow wealth, its corollary is that the drag of compounding fees can reduce wealth.
The script is becoming increasingly common. Sales of traditional variable annuities (VAs), unlike many other annuities, continue to decline more often than they rise. Last year, VA sales declined 3.2 percent, from $101.9 billion in 2019 to $98.6 billion in 2020, according to the Insured Retirement Institute (IRI). And in the second quarter of 2021, the latest figure available, sales fell 4.8 percent to $19 billion from $20 billion in the first quarter.
A few years ago, VA sales were roughly 20 percent higher, and before that even more so. This the case even though the stock market has been performing unusually well in the last three years.
What’s going on? Part of the answer is that VAs, by and large, are less attractive than they used to be, even more so than other annuities that have become less appealing because of rock-bottom interest rates. VAs don’t offer as many sub-accounts from which to choose and their income riders are generally less appealing than those of more popular fixed indexed annuities.
Other factors are in play as well. Traditional VAs are counted separately from a companion product – newer Registered Index-Linked Annuities (RILAs), which are structured variable products that use index options to provide both upside potential and downside protection. In the second quarter of 2021, these rose 11.2 percent to $10.2 billion from $9.2 billion in the first quarter. In addition, too many VA buyers opt for a guaranteed income rider, which sounds good but costs about 1 percent annually and undermines the returns of VAs in comparison to similar investments, such as stock mutual funds unburdened by this additional expense.
This leaves only one advantage to traditional VAs, and that is that unlike mutual funds and ETFs, they are tax-deferred financial products.
A White Paper sponsored by Jefferson National highlights just how much VAs with income riders fall short in comparison in comparison to VAs without them – so-called “investment-only” VAs. Over time, the White Paper says, investment-only VAs deliver 100 to 200 basis points more than VAs with income riders. It suggests, albeit doesn’t actually state, that the price of the rider isn’t worth this cost.
Wade Pfau, a CFA, Ph.D. and professor retirement income at The American College of Financial Services and among the most prominent retirement scholars, get to the heart of the matter in academic but nonetheless clear-cut terms. “There can be more efficient ways to obtain upside potential and downside protection than by buying a VA with an income guarantee,” he says in the Jefferson National study.
The White Paper explores how well an unguaranteed investment-only VA can replicate a rider’s guaranteed income payments. It’s based on an analysis of 5,000 Monte Carlo simulations on a low-cost investment-only VA and a traditional, hypothetical VA with a rider, combining characteristics of more than 30 popular guaranteed VAs and using more than eight decades of market data.
The upshot is this: Just as the power of tax-deferred compounding can grow wealth, its corollary is that the drag of compounding fees can reduce wealth.
According to the White Paper, whether a low-cost VA makes more sense for an investor than a traditional VA with a lifetime income rider depends on variables such as the length of tax-deferred accumulation before taking withdrawals, optimism about future market performance, and comfort with more aggressive investment objectives.
All of this is true, of course. But the fundamental lesson here is simpler. A traditional VA, as it currently exists, is not a good investment for many people. It may not be good even if you sidestep the income rider. Most investors are probably better off with a RLIA or a fixed indexed annuity. Both also offer tax-deferred income. But these two products also offer all or partial downside market protection, and, in the case of a RLIA, sometimes the potential to outperform perform the market. If you’re shopping for a plain-vanilla VA, why not take a look at a better deal?
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