RETAIL VS. NO-LOAD VARIABLE ANNUITIES
 

Perhaps you, like a growing number of Americans, have taken the opportunity to invest in no-load mutual funds. (They now make up over 50% of all financial products sold in the U.S.)  You have undoubtedly done this to take advantage of the lower cost associated with them.            For the same reason, you may want to consider placing a portion of your portfolio in a no-load variable annuity.  If you currently own a “retail” variable annuity, you will want to read carefully.  It could mean significant dollars down the road.

           

Viable Uses of Variable Annuities

 

Unfortunately, in many cases, variable annuities have been sold for questionable reasons. Before you can establish that an annuity is right for you, we need to review the suitable uses of them.

 

Tax Deferral.  This is perhaps the most publicized reason to have an annuity.  If you have reached the maximum in funding your qualified retirement plan, and have a 10+ year investment time horizon, it may make sense for a portion of your portfolio. Be aware that a 10% penalty (in addition to current income taxes) will be imposed on part, or all, of a withdrawal from an annuity, on a last in, first out basis, before age 591/2. Also, BE CAREFUL: Annuities do not receive what is known as a “step-up” in basis at death like other investment assets.  Therefore your heirs may in fact pay a substantial amount in income taxes on the annuity growth above the original investment in addition to estate taxes.

 

Lump-Sum Alternatives.  If you have money in CDs, or high-turnover mutual funds, all or at least a majority of the earnings will be taxed as ordinary income each year.  If you are not using these types of accounts to meet current expenses it may be an advantage to have a tax-deferred alternative.

 

Asset Protection.   In certain states, including Texas, annuities provide a shelter from creditors.  A physician who fears a malpractice lawsuit in our litigious society may use an annuity as a savings tool. Other individuals in economically hazardous occupations may also consider it as a protected investment. Consult an attorney or tax advisor in your area for more detailed information.

 

Guaranteed Income for Life.  An annuity payout period can be selected based on your income needs.  You can take the entire value of the annuity in a single lump sum, or you can withdraw money, as you need it. You can also set it up to make regular monthly payments for a predetermined number of years or your full lifetime. As you receive your payment, keep in mind that you must pay current income taxes on at least a portion of it.

 

Guaranteed Death Benefit.  Insurance companies often stress the value of this feature.  Most variable annuity contracts guarantee that upon the death of the annuity owner, the beneficiary receives either the value of the contract or 100% of the contributions, whichever is greater. An additional step-up benefit may allow incremental increases in the death benefit as the value of the annuity grows.

 

Avoiding Probate.  Annuities do not pass through a will but rather to a named beneficiary by operation of contract.  For this reason they can be given to the next generation without going through the often cumbersome and potentially expensive process of probate.  This also allows avoidance of the public record associated with probate.  This could be an advantage if privacy is a major concern.

 

Charitable Funding Vehicle.  A NIMCRUT (Net Income with Makeup Charitable Remainder Trust) can be a great tool for leaving a legacy while enjoying personal financial benefit.  Very simply, it is a charitable trust that is most commonly funded with a highly appreciated asset.  If you are looking for a way to sell a stock without paying the gains, this may be a solution.  An annuity works well in this scenario because the idea behind the NIMCRUT is to defer your income until you need it.

 

Greater Diversification.  Variable annuities allow you to move your money among several different mutual funds, or “sub accounts” without incurring transaction fees or surrender penalties. This flexibility applies even when moving between different fund “families.” This allows shifts when necessary to achieve or maintain proper asset allocation without tax complications.

 

What’s the Difference?

 

With these reasons established, let’s look at the differences between retail and no-load variable annuities:

 

Expenses.  It is not uncommon to find mortality and expense (M&E) charges that exceed 1.50 % in a retail annuity.  On the other hand, no-load annuity M&E charges can be as low as .20%.  This will affect the bottom line.  Also notable are the portfolio management fees that can exceed 2.00% in an actively managed stock mutual fund (sub account) of a retail annuity.  An institutional stock mutual fund in a no-load annuity can be as low as .10%.  Again, this can affect the ultimate value of your portfolio.

 

Surrender Fees.   When retail annuities are sold the agent or broker receives a commission.  This is a primary reason the insurance company places a surrender penalty on the annuity for as long as 9 years in some cases.  It is common to have a 7% penalty for surrender in year one.  The percentage usually declines each year until reaching zero.  By contrast, no-load annuities pay no commissions.  Therefore, there are no surrender penalties.  A management fee is negotiated with your financial advisor for managing the annuity.  The net result of this arrangement will nearly always be significant savings in expenses in the no-load annuity, which can positively affect your investment portfolio.

 

Investment Strategy.  Unlike in retail annuities, it is possible to provide access to Institutional Asset Class mutual funds inside a no-load annuity.  Asset Class mutual funds offer some additional advantages to those already mentioned.  1) Low operating and trading costs stemming from lower turnover.  These funds strive to achieve objectives by using structured management based on Nobel Prize winning principles of Modern Portfolio Theory (MPT).  Excessive trading in order to ‘pick’ the best securities is substantially reduced or eliminated.  2) Asset Class funds allow a consistent asset allocation. This enables you to maintain proper diversification among the various asset classes that are right given your personal goals and objectives. There is no ‘style drift’ such as is often present in the mutual funds of retail annuities.     

 

I Already Own a Retail Annuity.  Now What?

 

If you currently own a retail annuity, fixed or variable, that does not meet your current portfolio needs or is too expensive, you do have options.  After carefully analyzing the expenses in the annuity you own you may consider a 1035 exchange (referring to the IRS code section) into a no-load annuity.   A potential drawback of this approach is the existing insurance company surrender fee as discussed earlier.   This can also be analyzed in order to determine if the “cross-over point” of the reduced fees in the no-load annuity and investment option advantages is worth paying the fee to switch.  Remember that no variable annuity can guarantee positive returns, but at some point chances are good that a change of this nature may improve your situation.

 

If you do not own a variable annuity now and are considering one, first determine that your reasons for purchasing are prudent.  Avoid sales pitches in which your benefit is secondary to the agent’s or broker’s.  Find a fee-compensated investment advisor who will help you sift through the many available options putting your interests first and foremost.

 
 

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