Before becoming a financial advisor, I wholesaled variable annuities to financial advisors throughout the country. My main job was to educate advisors on how our products worked and fight for their clients’ business against wholesalers from other insurance companies. Back in 2012, it was a true competition of which company could provide the best performance, the lowest fees and the highest rate of withdrawals for clients in retirement.
Looking back, I would have loved to have any one of those products in the lineup to present my clients today. But with interest rates at all-time lows, the benefits inside variable annuities are not nearly as good as they were 10 years ago.
A few months ago, I found myself in front of a client couple who had most of their assets sitting in cash. They were worried about re-entering the market while the S&P 500 was reaching all-time highs. Without any pension between the two of them, and a conservative risk tolerance, we sat down and discussed the idea of taking 25% of their IRA assets to purchase a variable annuity. This way, they could participate in the market but also have that protection of income for when it was time to live off of the IRA.
Variable annuities can provide living benefit riders, which guarantee a growth percentage while you wait, and a guaranteed percentage of income later on. With most variable annuities, the client still has access and control of the account and a death benefit.
The New Game
In researching annuities to present to this couple, I was surprised by what was available, or rather not available. In the past when the 10-year Treasury would dip, you would see a lot of annuity companies reduce their growth and income rates for new contracts. For example, if a company offered a 5% guaranteed withdrawal for life, they might reduce that to 4.75%. Instead of seeing these kinds of normal decreases across the board, I saw a trend completely different and very discouraging.
Many companies are now offering a withdrawal percentage that can decrease over time. You heard it correctly, a “guaranteed income” that can actually go down in retirement. For instance, a company may offer as much as a 6% guaranteed withdrawal for life, but if the account value goes to zero, the withdrawal goes to 3%. This means a possible 50% pay cut in retirement if the account goes to zero during the account holder’s lifetime.
No laws have changed, the annuity companies just are able to determine how they want their “income riders” to work on their annuities. They are technically insurance contracts so these companies can really do whatever they want as long as they disclose it.
Some wholesalers for these annuity companies will try and convince you that the probability of an account value going to zero is very slim, but I disagree. And here is why:
Imagine a client taking a 6% withdrawal every year in a variable annuity that costs about 3.5% a year. This percentage includes an average 1% mortality and expense, an average 1.5% for the income rider and an average 1% for the underlying subaccount investments. Imagine that same client starts their income stream on a down year in the market and the value goes down by 5%. In one year, the account value has decreased by 14.5%. Although year after year the investments inside the annuity may go up or stay flat, the account value is getting hammered by withdrawals and relatively high fees.
[The SEC has recognized that variable annuity contracts can be complicated and has published a bulletin that among other things, explains that consumers can lose their original investment. Finra requires clients to be informed of all contract features.]
Are Variable Annuities Dead?
If you start withdrawing income from an annuity like this at around 70 years old, you could indeed find your account value hitting zero 15 years later. As a financial advisor, how do I respond to that phone call? The phone call from the client saying that they just got a 50% pay cut.
Most times, people purchase these annuities for the guaranteed paycheck for life that doesn’t go down and doesn’t go away. But if this paycheck for life is actually not guaranteed at the initial withdrawal rate and is likely to go down when people need income the most, then where do annuities stand? Are variable annuities dead?
After a lot of researching, I was able to find an annuity that I felt was a good fit for this couple. But this process gave me a glimpse of what the future landscape of annuities will look like and it isn’t pretty.
For those who are looking for an annuity to include in their retirement plan, do your research. “Look under the hood” and figure out the annual fees, how long the surrender charge period is, if the income percentage can be reduced, and how the advisor is getting compensated. Clients should also be informed that withdrawals made prior to age 59½ may be subject to taxes and possible penalties.
Annuities can be a beneficial part of a retirement plan but they are not for everyone.
Elizabeth “Betsy” Madonna is a vice president – wealth manager at Steward Partners Global Advisory in Philadelphia. You can read more about her here. Steward Partners Global Advisory, LLC offer securities through Raymond James Financial Services, Inc. and offers investment advisory services through Steward Partners Investment Advisory, LLC.