Favorite Child

Nothing New
The strategy of using annuities for the tax advantages isn’t new. VAs were introduced in 1952 primarily for tax-deferred savings, at a time before IRAs and 401(k)s and such existed. Over time, annuity providers sweetened the deal by adding riders with a variety of living benefits. The idea of using VAs just for tax deferment fell by the wayside. “It was an ignored category,” says Lincoln’s Herr. “So this is a kind of back-to-the-future, using variable annuities more for wealth accumulation than for the living-benefit riders.”

Michael Rosenberg, managing director at Diversified Investment Strategies in Livingston, N.J., might agree. “Annuities have been traditionally used by high-net-worth individuals to shelter funds they probably will not need during their lifetimes, especially when [they have] maxed out their qualified plans,” he says. “Originally, living benefits were not the main draw of annuities.”

For Nonqualified Money
As part of a tax-deferment strategy, these simplified VAs are not intended to replace other instruments. They should only be used after clients have exhausted all other forms of tax-deferred savings. That’s partly because it’s best to get the full value of any employer-sponsored savings plans. Also, when IRAs—or any other form of mutual fund, for that matter—are liquidated, gains are taxed as regular income, which is typically at a higher rate than capital gains.

To get the full value of tax deferment, some suggest this is a tactic for the young. The more years one’s savings build without taxation, the better. But others don’t necessarily see it that way. “While they often have time on their side, young people typically do not have large amounts of excess cash available due to obligations like a mortgage, college loans and raising a family,” notes Rosenberg.

Indeed, in addition to first maximizing IRA and 401(k) contributions, it’s a good idea to set aside enough cash for expenses before purchasing a VA. Many VAs have early-withdrawal penalties, and even those that don’t may incur tax penalties if funds are withdrawn before age 59 1/2.

Weighing Options
In fairness, the arguments against simplified VAs are many. “An investment in VAs would make sense only after maxing out IRAs, etc., and setting aside money for more immediate needs, such as a new home or repaying college loans—and even in that case, the VA will be competing with tax-advantaged mutual funds,” says Glenn Daily, a fee-only insurance consultant and principal at Sutter’s Mill Valuation Services in New York. “So this situation is not going to apply to many people.”

Where Daily does find VAs particularly valuable is as a substitute for certain other undesirable assets. “My primary use for variable annuities is to preserve the cost basis of life insurance policies that are no longer wanted,” he says. “This is especially useful when the cost basis is much higher than the cash surrender value. For example, if the cost basis is $100,000 and the cash surrender value is $60,000, you can do a tax-free exchange to a variable annuity, and the next $40,000 of gains will be tax-sheltered by the excess cost basis.”

Yet another factor in weighing low-cost, low-benefit VAs is the variety of underlying investments available. Lincoln Financial’s Investor Advantage, for instance, comes with a choice of 135 investment accounts. Basic annual charges are 1.10%. In contrast, Jefferson National’s Monument Advisor charges a flat fee of $240 annually and offers more than 350 account choices, which is an industry high.

But it’s not just a numbers game. “Many lower cost investment-oriented VAs also offer clients access to non-traditional asset classes and strategies that they may not otherwise be able to invest in,” says Elizabeth Forget, an executive vice president at MetLife’s Retail Retirement and Wealth Solutions offices in Charlotte, N.C.

MetLife’s own Investment Portfolio Architect, which has more than 80 funds to choose from, with fees starting at 1.10% plus $30 a year, not only has a range of investment choices but also offers interactive tools to help clients evaluate different combinations of options. They can construct their own customized portfolios or “choose from professionally developed ‘Blueprint Models,’” says Forget, “or combine these approaches to find the right fit for them.”

More Varieties On The Horizon?
In a growing product category, you can expect more varieties and features to be in the offing. “We expect more innovation in the types of investments that are available, the options that clients and their advisors have to manage their accounts, and new distribution strategies for clients in retirement,” says Forget.
How VAs are sold may be evolving, too. Jefferson National, for instance, which is a no-load provider, “exclusively serves RIAs and fee-based advisors who will not take commissions for selling products, but choose to be paid an advisory fee by their clients,” says Greenberg.

Different types of riders are also likely to emerge. Some industry analysts insist that the advantages of riders can’t be ignored—especially if they aren’t too expensive. “We still believe guarantees are important, so we offer low-cost optional death benefits and a deferred income annuity (DIA) rider for no additional cost,” says Douglas Dubitsky, vice president of retirement solutions at Guardian Life in New York. Clients “can move assets out of the market after the second contract anniversary and into the DIA rider to purchase guaranteed income for life.”

In fact, keeping track of annuity options can sometimes feel like trying to hit a moving target. “We are all monitoring investor needs and assessing what’s right for clients,” says Dubitsky. “We are expecting to see more low-cost variable annuities, but only as one of many flavors of annuities that a carrier will sell in order to have a well-rounded retirement solutions offering to fit varying client needs.”

For now, though, one clear need seems to be reduced fees. “The best-interest standard fiduciary duty provision from the Department of Labor will create more pressure on fees, and the industry will respond,” notes Rosenberg.

Whether that pressure will come from regulators or wallet-conscious clients is less clear. “The country is fee-conscious,” says Haithcock. “We live in a Walmart world, an Amazon world. It’s a world where people shop for bargains. I think annuity providers are being forced by the consumer to evaluate their products, their fees. And the rising popularity of the low-cost variable annuity is a reflection of that.”