Variable annuities OKThis is in response to Marlene Givant Star's Nov. 27 Opinion Page column, " The overselling of variable annuities." Let us first say we agree that a number of individual investors and plan sponsors don't fully understand variable annuities. Also, we at the National Association for Variable Annuities believe it is in the individual's best interest to first fund any tax-deductible plans such as 401(k)s.
The unique combination of features available with variable annuities makes them suitable for both qualified and non-qualified plans. Variable annuities, unlike mutual funds, were specifically designed for retirement and include features designed for this market. These features include the combination of the variable portion and the guaranteed fixed account in one funding vehicle, the ability to convert into a guaranteed lifetime income with a wide range of payout options, a guaranteed death benefit and the convenience of having everything on one statement. The average additional charge for having all of these features in one product is only 72 basis points.
This 72 basis point total average cost difference between variable annuities and mutual funds is based on a study done by Lipper Analytical Services in 1994. Some studies have shown higher cost differentials but these studies are flawed because they use similar management fees for both variable annuities and mutual funds. Transfer agent fees cover all expenses related to the administrative aspects of thousands of individual mutual fund accounts. Variable annuity management fees are generally lower because the transfer agent fees are included, not in the management fee, but in the administrative expense in the insurance charge. Not accounting for this distinction would have the effect of counting the transfer agent fees twice.
The column did not mention fixed accounts of variable annuities. These accounts, which are not subject to the variable account fees, provide a stated rate of interest that is reset according to the terms of the individual contract. In 1993, when rates were at historic lows, 33% of mutual fund assets were in money market funds. Historically, variable annuity fixed accounts have offered higher rates than money market funds. We believe the difference in fees between mutual funds and variable annuities would be largely offset by the higher rates offered in the fixed account.
The additional variable annuity fees pay for the additional features, not for tax deferral. The most important feature, and the most costly, is the ability to turn your variable annuity into a steady stream of income which can be guaranteed for life. Studies have shown the variable annuity can provide significantly more after-tax income during retirement than a mutual fund.
Longer life expectancies due to medical advances and better health habits are expected to continue, making lifetime income even more important. Purchasing an annuity now allows you to guarantee a minimum benefit based on current mortality tables.
The death benefit is another important feature paid for by the variable annuity account fees. This benefit is usually stepped up over a period of time and allows the investor to invest more aggressively without worrying about the effect on his or her heirs. We have found this feature to be very important to older investors.
The column mentions few if any small investors will have any savings dollars left after making the maximum contributions available to a company plan or an IRA. Some smaller companies have low limits on contributions to a plan, and as people age they often find the IRA limits too low. Annuities allow tax-deferred "catch-up" savings for those who need it most. Baby boomers are particularly affected by the changes in pension plans and have difficulty saving. Putting prohibitive minimums on variable annuities may force people to pay taxes on what little they have to save.
A recent study by a Stanford University economist reveals the average baby boomer must roughly triple his or her rate of savings or face a potentially precipitous decline in standard of living at retirement. A variable annuity is a highly efficient way to accumulate dollars for that goal.
Also, portfolio managers of funding vehicles for variable annuities (which are not, as the column states, open-end mutual funds) need not be concerned with the tax implications of their transactions. Their investment management decisions can be based solely on market conditions. In contrast, managers of retail open-end mutual funds may hold off selling stocks in an effort to postpone capital gains. Fund performance could suffer because of the need to maintain cash balances to meet redemption demands; thus investment opportunities may not be fully exploited. Given these considerations, it could be argued annuities offer a greater potential for increased earnings.
Our interest in voicing these concerns is to advance our common cause of educating the investing public about variable annuities. Many financial magazines omit what we believe are important aspects of the product when they discuss variable annuities. Your publication is an important voice in the finance arena and we believe you strive to provide complete information.
Mark J. Mackey
Joseph W. Jordan
National Associationfor Variable Annuities