Last year, overall annuity sales rose 3% to $235.8 billion, as measured by LIMRA. But sales of variable annuities fell 4% to the lowest they’ve been since 2009: $140.1 billion.

The reasons for that drop are myriad, but what may be most surprising and telling is that one type of VA was an exception: the simplified low-cost, low-benefit variety. “Over the last three years, total variable annuity sales were up an annual average of about 9%, but those with living-benefit riders were down about 11%,” observes Radnor, Pa.-based Michael Kazanjian, vice president for annuity and retirement-plan marketing at the Lincoln Financial Group. “That shows that investment-focused VAs are a growing category in the industry.”

These VAs offer no add-on benefits such as income guarantees or long-term-care coverage. Like all VAs, they invest assets in underlying mutual fund-like subaccounts that grow tax-deferred. The big difference is their fees are much less because of the lack of additional benefits. You save money by not tacking on so-called living-benefits riders.

Lincoln Financial’s version of this kind of stripped-down, low-cost VA, called Investor Advantage, garnered $100 million in sales in the first 100 days following its June 2014 launch. “We’re doing well in this category,” confirms Dan Herr, head of Lincoln Financial’s annuity project management in Hartford, Conn.
Competition, however, appears to be fierce. Jefferson National’s popular Monument Advisor, for example, an investment-only VA introduced in late 2005, saw sales grow a whopping 77% in 2013 and another 4.5% last year to more than $760 million in 2014 alone, according to Laurence Greenberg, president of the Louisville, Ky.-headquartered annuity provider.

A Bargain
Why these products are growing increasingly popular, and where this trend will lead, are compelling questions advisors would do well not to ignore.

One obvious explanation: They are cheaper. “The average annual fee for a loaded variable annuity is at least 3% and sometimes as high as 5%,” says Stan Haithcock, the Ponte Vedra Beach, Fla.-based annuity expert known as “Stan The Annuity Man.” “That alone led a lot of investors to complain to their carriers or stop buying them. When you buy a variable annuity without an income rider, without a guarantee on it, the choice really comes down to the fees and the investment selection.”

But at what point is that bargain worthwhile? To invest in the equivalent mutual fund would almost always cost less. The only advantage, then, is the tax deferral.

“Studies show that tax deferral can add upwards of 100 to 200 basis point of alpha to help increase returns—without increasing risk,” says Greenberg at Jefferson National. He adds that investment-only VAs are “an innovative vehicle for asset location, a method to tax-optimize tactical strategies and liquid alternatives [and] a tool to enhance trusts or stretch assets for a next generation of clients.”

Using VAs for tax deferral may make the most sense for high-net-worth individuals who have already maxed out their other tax-favored options such as IRAs and 401(k)s. (For 2015, the contribution limits for 401(k) plans are $18,000 for those 49 and younger, and $24,000 for investors 50 and older.)