Investment managers of variable annuities raked in $50 billion in assets last year. Disturbingly, half of the assets invested in these tax-deferred insurance contracts were from already tax-protected plans. Dan Moser, a contributing editor of Louis Rukeyser's Mutual Funds, likened the phenomenon to wearing a raincoat indoors.
Clearly individual investors and plan sponsors don't understand these products, which typically invest in open-end mutual funds.
The financial intermediaries that have been the dominant sellers of variable annuities to individuals in tax-exempt plans such as 457 and 403(b) plans, as well as on the retail level, have done a poor job educating customers. Now, direct marketers have begun offering their own variable annuities on a no-load basis, meaning there is even less one-on-one communication with the consumer. Of course, these direct marketers pride themselves on their ability to educate investors to make their own informed choices.
Indeed, their marketing materials are thorough and lucid in their explanations of how annuities work, the costs involved and whether they make sense.
The brochures point out that unlike contributions to individual retirement accounts, variable annuity contributions are not tax-deductible.
On the plus side, there is no cap on how much can be invested each year in variable annuities, and they offer payout options that can provide guaranteed income for life and a death benefit.
The brochures invariably point out variable annuities are costlier than IRAs because of their insurance features and therefore investors should not consider them until they have "maxxed out" their savings using other tax-deferred options such as company-sponsored retirement plans and IRAs.
Unfortunately, the actions of these fund companies contradict the prudent advice in their sales brochures, sending investors the wrong message. Few, if any, small investors will have any savings dollars left after making the maximum allowable contributions to company-sponsored plans and IRAs. Yet most direct marketers offer very low initial investment minimums, ranging from $1,000 for the Janus Funds and $2,500 for the Scudder Funds to $5,000 for the Vanguard Group.
The minimum initial investments allowed in these variable annuities are so low they might lure misinformed investors, who probably shouldn't be using variable annuities at all because the costs offset the benefits of tax-deferral.
Maybe fund companies offering variable annuities should look to one of their newest competitors, T. Rowe Price Associates Inc. It offers a variable annuity with a more appropriate minimum - $10,000 - far above the firm's investment minimum on regular mutual fund investments.
Brokers and direct marketers alike need to recognize that ensuring an investment is a good fit for customers is just as important as disclosing the risks. Increasing investment minimums would be one step in the right direction, so that maybe next year the industry's stunning asset growth will come from the wealthier, taxable individual investors who can truly benefit from variable annuities.