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I Hate (Most) Variable Annuities

Investment Management Financial Planning Retirement Planning

As much as I love to partner with families to dramatically simplify their complex financial lives, that’s how much I hate most variable annuities. That’s a lot of loathing. And I am not alone:

  • In “The Only Guide to Alternative Investments You’ll Ever Need,” BAM ALLIANCE co-authors Larry Swedroe and Jared Kizer panned most variable annuities, noting that, “Sales are often in the best interest of the person making the recommendation to buy them – although they may not be in the best interests of the buyer.”
  • The Financial Industry Regulatory Authority (FINRA) also has warned investors away from them in this alert: Variable Annuities: Beyond the Hard Sell.
  • Even the Aloha state of Hawaii placed them on their list of top-five Common Threats to Hawaii Investors, right up there with Ponzi schemes and affinity fraud. The clip art is a little cheesy – a thief sneaking off with the goods – but it may not be entirely off-base.

As described in the Hawaiian regulatory report, variable annuities are “complicated products that agents sell without thoroughly explaining.” These sentiments echo Larry’s and Jared’s similar comments in their book, where they explain the flaws described here in more detail. (To be fair, they also suggest a handful of circumstances in which a sensibly structured variable annuity may make sense, although these have been more the exception than the rule, by far.)

Let’s count a few of the ways that I hate most variable annuities.

Incredibly Complicated

Annuity structures in general can be mind-numbingly complex. The contracts are lengthy, confusing and obtuse – unreadable and unread. Granted, even well-written financial agreements for legitimate products can get hairy. But as a trading professional turned wealth manager, I’ve scrutinized a lot of detailed investment contracts over the years, and even I sometimes have a hard time determining the all-in costs and net performance expectations on these things.

Inherently Conflicted

From my conversations with your average variable annuity sales folk, they rarely seem to understand the intricacies either – or if they do, they’re not admitting to it.

Given the nosebleed-high commissions they’ve traditionally stood to reap, it’s no wonder these product purveyors don’t want to take a close whiff of their own wares. As described in this February 2016 Wall Street Journal piece, the commission on a variable annuity sale averaged around 8% in 2014. So on $100,000, that’s $8,000 gone, before you’ve even driven the annuity off the proverbial lot. I’ll bet that a car dealer would live in envy of these sorts of payoffs.

Insufferably Deceptive

If that were all of it, I suppose one could argue that it’s a caveat emptor world, where it remains the buyer’s duty to beware. But with variable annuities, some of the deceptions I’ve seen used to promote the product create an unfair playing field.

The biggest one that sticks in my craw is when annuities are touted as dependable safeguards against losing your retirement nest egg to market volatility. Who wouldn’t want to hear that they could earn 6% (or similar) every year, guaranteed for life? I’ve even had family members come to me after hearing these sorts of pitches, asking about these allegedly risk-free alternatives to traditional investing.

That’s dirty pool. Of course we all want investment returns without risk. We’d also all love it if deep dish, Chicago-style pizza were low-fat, and those “I want to give you $1 million” e-mails from Nigerian royalty were for real. On the last two counts, we immediately know better. I suggest you treat any claims that you can earn “risk-free” market returns with equal suspicion.

Would you like to know the sleight of hand that’s likely taking place? With variable annuities, you’re not necessarily earning a 6 percent (or whatever) return ON your capital. If the underlying investments don’t deliver as hoped for, what you may get instead is up to a 6 percent return OF your capital … at least until you die, the contract ends, or your money runs out. In other words, you may be basically borrowing against your own nest egg to achieve so-called security.

Once you know how it may really work, those “guaranteed” returns lose their appeal fast, don’t they? Even if you’re okay with establishing a reliable plan for spending down your assets – a common and often commendable goal for retirees – you or your adviser can set up a similar arrangement on your own. It can usually be done far more transparently, with better underlying investments, at a fraction of the cost, and with a lot more liquidity, so you can make adjustments over time if your goals or circumstances change.

Variable Annuities: A Thing of the Past?

Fortunately, I and others long committed to representing investors’ best financial interests may not need to warn people away from these sorts of flimflam products for much longer.

Compliments of the Department of Labor (DOL), new fiduciary rules governing retirement plan advice are scheduled to go into effect beginning in April 2017. The DOL’s rules don’t specifically prohibit the sale of variable annuities, but they do require anyone offering investment advice for retirement accounts to do so in a fiduciary manner. That means any investment recommendations must be in the investor’s highest financial interests.

That’s going to make inherently complex, conflicted and costly variable annuities a tough sell.

Even though the DOL’s rules are still months or more away, they seem to already be having a positive impact on the industry:

  • A May 2016 InvestmentNews article reported data from a LIMRA Secure Retirement Institute survey that found 19 of the top 20 variable annuity providers reported decreased sales in the first quarter of 2016. The LIMRA survey also found that “the market share of variable annuities compared to overall annuity sales dropped to its lowest level in more than 20 years.”
  • An August 2016 InvestmentNews article indicated the decline was continuing: “Sales [of variable annuities] are expected to continue their downward trajectory as the [DOL] regulation comes into effect starting next year.”
  • Another financial trade publication, RIABiz, quoted a Cerulli Associates research team managing director, who described the impact of the DOL rule as “almost an existential crisis for variable annuities … You can make the argument for the role of guaranteed income in retirement accounts but is it worth paying the high fees?”

We would say, no, high fees are rarely, if ever “worth it,” at least not for the investors who are paying them. If the DOL’s rules spell the demise of poorly structured variable annuities and similarly conflicted products, I say, bring it on. Way to dramatically simplify investors’ complex financial lives.