Income Quest

Annuities—opinions about them may run the gamut, but their market certainly can’t be ignored. Total annuity sales last year reached $230 billion, as measured by the Limra Secure Retirement Institute.

“Annuities are designed as two-stage investments. Accumulation is stage one; distribution is stage two,” says John Graves, a chartered financial consultant in Ventura, Calif., and author of The 7% Solution: You CAN Afford a Comfortable Retirement.

But how can annuities serve these dual purposes? And which annuities are best for asset accumulation and which for income generation?

The Best Of Both Worlds?
“In general, the variable annuity with an income rider is the best solution,” says Joe Heider, regional managing principal at Rehmann, a full-service firm in Westlake, Ohio. “This allows investors to stay invested, with potential for higher returns if the market does well, but provides a downside guarantee if the market should take a downturn before or in retirement years.”

Heider isn’t alone in this view. Variable annuities (VAs) with an income rider have grown steadily more popular in recent years, though detractors charge that their fees are too high. “It is expensive relative to buying mutual funds, ETFs or professional managed accounts,” concedes Heider. “However, the additional expense in large part is buying the insurance to protect the income stream.”

Beyond the fees, VAs with guaranteed living benefits are subject to complex rules. “They are too complicated for the vast majority of consumers and their financial advisors to use,” insists Glenn Daily, principal at Sutter’s Mill Valuation Services in New York. “The economic valuation of these benefits requires option-pricing methodology, so it is very difficult to provide competent advice on the purchase decision as well as on optimal exercise decisions (including buyout offers) after purchase.”

Asset Growth
So other experts prefer a different sort of product for asset accumulation—separating that function from income generation. “One problem in the annuity industry is that variable annuities are sold for both growth and income, which is a mistake and one reason the industry continues to give itself a black eye,” says Stan Haithcock, the annuity maven known as “Stan The Annuity Man,” in Ponte Vedra Beach, Fla. “This one-size-fits-all, have-your-cake-and-eat-it-too nonsense is a major problem.”

Haithcock says that VAs are good accumulation vehicles but “not very competitive” from an income standpoint. “If you want to do growth, then do growth. But once you attach an income guarantee to it, that’s going to limit your investment choices and add fees which will eat into the growth,” he says.

To Haithcock, the best annuity for asset accumulation is a no-load VA. A good example is Jefferson National’s investment-only variable annuity (IOVA). Other insurers like Jackson National have entered the fray. With no purchase fees or early-redemption charges and low operating expenses, these vehicles offer tax-deferred growth, complete liquidity and exposure to hundreds of investment choices.

“Jefferson National offers nearly 400 underlying investment options, which is nine times more than the typical VA,” says Wade Pfau, professor of retirement income at the American College in Bryn Mawr, Pa., who is affiliated with the product. “Jefferson National provides a broad range of different asset classes, including more non-correlated asset classes, hybrid investments and liquid alternative funds that employ strategies for managing volatility like those favored by hedge funds and elite institutional investors.”

This flexibility is designed to allow clients and their advisors to be as aggressive or risk averse as they wish and maximize long-term performance. For clients who are especially concerned about market volatility, there are a couple of safeguard options. “Managed volatility subaccounts or guaranteed principal protection riders can offer additional comfort during the accumulation process,” says Judson Forner, director of investment marketing at ValMark Securities in Akron, Ohio.

The Downside
Yet IOVAs are not necessarily right for every seeker of asset growth. “That type of annuity is a fit in very specialized circumstances,” says Rehmann’s Heider, citing wealthy and young clients. “The trade-off here is that you’re deferring taxation but you’re converting potential capital-gains treatment into ordinary income. The primary purpose of annuities should be protecting tax accumulation and some type of enhanced income protection.”

Indeed, some experts go so far as to say that using annuities of any type to grow assets is usually a mistake. “I don’t think an intelligent planner or advisor would want to use an annuity as an asset-accumulation vehicle,” asserts Kurt Cambier, a senior partner at Littleton, Colo.-based Centennial Capital Partners. “An annuity is a protection and income vehicle.”