Five Warning Signs When Examining A Variable AnnuityAdvisor Perspectives
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Kudzu invaded the South, obliterating the healthy and attractive vegetation carefully planted by homeowners. Variable annuity (VA) owners are likewise being strangled by excessive fees.
When kudzu came to the American south, homeowners valued it for its broad tri-folate leaves’ ability to shade their steamy summer porches. A highly invasive species native to Asia, kudzu favors any light or shade condition, can root in any soil and, because its leaves can fix atmospheric nitrogen, it can even thrive in the poorest soils. It now grows so thick in rights-of-way, abandoned rural properties and old fallow fields that the shade that made it so valuable to homeowners chokes out all other vegetation and timber.
What made it so good has made it so bad.
Like the “vine that ate the south,” annuity riders and guarantees – long sought for protections that other investments cannot provide – tangled around the annuities themselves, making them illiquid, complex and expensive. In the race to design the “next big thing,” insurers abstracted the solution from the vehicle by focusing on complex features that have been commoditized.
Anecdotally, the RIAs I work with tell me they don’t understand annuities and they don’t want to take the time to understand them – for good reason. Annuities are often expensive, opaque and difficult to understand. The value of tax deferral can be completely wiped out by fees and charges (often 3% or more), and their clients can’t make sense of the product.
These products were initially constructed by insurers to reduce risk that investors were unwilling to shoulder, but Vas have grown overly bloated – choked with the vine-y mangle of features clients may never need and certainly will never fully understand.
A client walks in with an annuity…
I hear this all the time: “This client walks in with an annuity…” It sounds like the opening line of a joke. Sometimes the punchline is good. Sometimes not so much. Because RIAs aren’t insurance-licensed, when a new or prospective client reveals an annuity in their portfolio, or asks for guaranteed solutions, they may be at sea as to what to do. Usually there are three courses of action they can take:
- Refer the prospective client to an insurance-licensed agent;
- Ignore the annuity; or
- Call an objective annuity expert to analyze it and offer guidance.
The first option is risky – who’s to say an agent, apart from your practice, has your client’s best interests at heart? And the second option doesn’t work well for those who want to guide their clients holistically. The best option is for an advisor to work with experts she/he trusts to analyze these annuities for them and offer recommendations.
You can look for five fees that will tell you a lot about a VA – and then you get to deliver the punchline.
Look for these fees and charges
If you’re looking to move a client out of an expensive old VA, into a solution to extend tax deferral, or are seeking out the protections an annuity offers on behalf of a client, look for these primary fees and charges: mortality and expense risk (M&E), administration charges, rider fees, surrender charges and underlying fund expenses. Insurance companies are required to file prospectuses for all VAs, so you should be able to Google your client’s current (or proposed) annuity prospectus and use the handy ”find” (ctrl-f) feature in your PDF reader to locate these costs and examine them.
- Mortality and expense risk (M&E)
M&E risk charges can range anywhere from a few basis points to 200 or more, depending on the product. Investing isn’t free, and this is how the insurance company pays itself (and possibly the insurance agent who sold the annuity). When assessing an annuity, the first place to look is at this cost. This is what your client will pay for tax deferral and any on-board features. Morningstar® and others have estimated that the value of tax deferral is somewhere between 100 and 200 basis points annually. Keeping M&E costs minimal will allow your clients to truly benefit from the compounding power of tax deferral. A base M&E below 60 basis points is a good place to start.
Vas offered for commission will have higher M&E charges than no-load, fee-based variable annuities.
TIP: When considering a VA, look for no-load or investment-only products.
Read the full article here by David Stone, Advisor Perspectives