If
the Department of Labor’s Fiduciary proposal goes into effect,
advisors may find themselves taking a closer look at low-cost
annuities.
The push by regulators for greater advisor accountability and more
prudent investment recommendations will be a boon for products that
offer client-friendly features and lower costs. This may encourage
more annuity providers to compete on price.
Advisors have slowly embraced low-cost annuities in recent years, and
their sales have jumped from $3.6 billion in 2010 to nearly $6 billion
in 2014, according to the Insured Retirement Institute, the trade
association that represents annuity sellers. The IRI defines low-cost
as variable products that have no sales commissions or surrender
charges and keep their annual expenses under 1%.
Bells and whistles like income guarantees, living benefits and payouts
indexed to stock market returns have increased these products’
popularity among some advisors and their clients. Although relatively
unheard of 15 years ago, there are now more than 220 living benefit
products in the variable annuity space, Morningstar analyst John
McCarthy says.
DRILLING DOWN ON VARIABLES
Variable annuities are complex beasts. Since they are amalgams of
mutual funds with myriad benefits, they have several layers of fees.
The mortality, expense and administrative charge pays for the cost of
the insurance, administration and commissions; this is expressed as a
percentage of the amount in the account. According to AnnuityFYI, an
online annuity service, the average industrywide fee is 1.4%. Charges
below 1% put the product in a low-cost category. So-called no-load
annuities don’t pay commissions.
Insurance companies don’t want customers withdrawing too much of their
money too quickly, so they impose surrender fees if funds are
withdrawn before a certain time period (seven years on average).
Low-cost products don’t have surrender fees, and there are also short
surrender products that are subject to withdrawal surcharges for only
a few years.
Variables also charge subaccount fees, known as expense ratios in the
mutual fund world. These are what fund companies charge for managing
funds within the annuity, and they vary widely from more than 1% to
under 0.3%.
There are also miscellaneous fees such as maintenance charges, which
are usually flat fees. The industry average is $35, which may be
waived for accounts over $50,000.
SPECIAL RIDERS
As
with most insurance products, clients pay extra for special riders
such as lifetime income and enhanced death benefits. Those options
tend to add 0.4% to 1.1% to annual expenses. Here are two examples of
popular riders and their average cost:
Guaranteed Minimum Income Benefits:
For clients who want to lock in a payment, these riders guarantee a
minimum monthly benefit regardless of the underlying performance of
the product. But they typically don’t kick in until after the 10th
year of the contract and they apply only when the client annuitizes.
But they also add from 1% to 1.15% to the annual expense.
Lifetime Income Benefits:
A form of longevity insurance, this is another failsafe that
guarantees a payment even if the account balance goes to zero. Say
your client purchased a $100,000 annuity with this rider guaranteeing
a 5% return. If the balance went to nothing, there would still be a
$5,000 annual withdrawal.
To
cover a spouse along with your client, you can also buy a joint and
survivor product. Expenses are 0.35% to 1.25% annually.
Keep in mind that there are hundreds of variations of these products
with specific rules on withdrawals, rates of return and other
contingencies. The more features you want, the more you’ll have to vet
the product for its suitability and cost.
THE LEADING PROVIDERS
There are a handful of companies that are acknowledged to have the
lowest cost structures. All of the variables offer an array of mutual
funds, but they vary in cost depending upon their objective.
You’ll pay the least for a broad-index fund — like those offered by
Vanguard — and the most for those with more specialized objectives.
The average subaccount expense is 0.96%, which is slightly lower than
stand-alone mutual funds, according to Morningstar.
Here’s a sampling of mostly direct-sold products that don’t pay
commissions:
Generally, the largest low-cost providers have been in the business
for decades, are active in the institutional market and offer
economies of scale. TIAA-CREF, for example, a retirement plan manager
(originally for college professors), offers an Intelligent Annuity
product with subaccount fees as low as 0.09% annually.
Pressure to achieve cost savings has led to quite a bit of
cross-pollination among these products. Vanguard, for instance, a
traditional low-cost mutual fund complex, may be represented in other
plans, such as Jefferson National. Likewise, you can find low-cost
funds from Dimensional Fund Advisors in several annuity programs.
Advisors seeking bargains for their clients can take advantage of this
competition.
“If an appropriate client situation surfaces, the lowest-cost variable
annuity that I am aware of is the Jefferson Nation Monument Advisor
annuity,” notes Gil Armour, a CFP with SagePoint Financial in San
Diego. “Instead of a hefty 1.25% mortality and expense ratio like most
annuities, they charge a flat $20 per month,” he explains. “In the
right situation, that could save the client a lot of money in ongoing
fees.”
ANNUITIES AND THE FINANCIAL PLAN
When choosing among annuities or deciding whether to use an annuity at
all, an advisor must consider a variety of factors.
Taxes are one consideraion. Since withdrawals are taxed at full
marginal rates as ordinary income, the only advantage of annuities
from a tax perspective is their ability to defer them. A tax-efficient
portfolio of mutual funds or exchange-traded funds that generates
capital gains at a lower tax rate may be more suitable for many
clients.
The use of riders is another factor. These require a further
cost-benefit analysis, since advisors have to weigh the additional
expense against alternative strategies to protect their clients’
future income.
“Riders may be more expensive than a mutual fund or managed
portfolio,” says Joe Heider, president of Cirrus Wealth Management in
Cleveland. “They cost from 1.25% to 1.5% extra. Are they worth it?”
Besides comparing annuities’ costs and features, another basic
consideration is the financial strength of the issuing company.
annuity selection
But annuity selection depends greatly on clients’ inclinations and
risk tolerance. Some may insist on a guaranteed income benefit and be
willing to pay the extra cost. Others may be more interested in saving
money and boosting returns with a lower-cost platform. In that case,
you may be able to switch them through a 1035 Exchange of similar
insurance products into a no-load, no-surrender fee annuity with low
subaccount fees.
Selecting an appropriate annuity also depends on the kind of advisor
you are. Those tied into broker-dealers or wholesalers may access
entirely different products than advisors who operate as fee-only
planners under a fiduciary model.
Eve Kaplan, a fee-only certified financial planner in Berkeley
Heights, N.J., says she typically avoids recommending non-qualified
variable annuities in part because of higher taxes on withdrawals.
“I’m not sure why you would want to invest in a variable annuity with
after-tax dollars and incur ordinary income tax rates on capital
gains,” she says, “when you can benefit from the current [lower]
capital gains rates available in taxable accounts.”
But for advisors who recommend annuities, the Labor Department’s
proposed fiduciary rules for retirement advice have the potential to
be a game changer.
If
commission-based advisors are forced to hew to a new fiduciary
standard, they will inevitably pay much more attention to the
lowest-cost products and rethink some of the retirement income
strategies they offer.
John F. Wasik is the author of Keynes’s Way to Wealth and 13 other
books. He is also a contributor to The New York Times and
Morningstar.com. Follow him on Twitter at
@johnwasik.
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