Sales of traditional variable annuities have taken a substantial hit in recent years, but a subset of the product class continues to attract clients who are set on increasing tax-deferred savings potential in pre-retirement years.
The investment-only variable annuity (IOVA) is a type of variable annuity that is generally attractive because of its lower price tag and unique investment opportunities—paired with the traditional tax-deferral offered by a nonqualified annuity product. However, unlike the guaranteed income appeal of the traditional annuity, the primary appeal of the IOVA lies in the magnification of income tax deferral through the unique investment diversification opportunities offered by the product.
The Investment-Only Variable Annuity
IOVAs are a subset of variable annuity that are, as the name suggests, focused on the investment potential of a tax-deferred annuity product. Importantly, these products offer the same tax-deferral benefits as a traditional annuity product, so that the income earned on investments is not taxed until the accumulated funds are withdrawn.
IOVAs are also attractive because the fees that a client must pay to maintain an IOVA are much less than those applicable to other types of annuities (some products offer a flat fee that is as low as $20 per month, and many products have no surrender charges). Studies have shown that this allows for more robust investment growth, as the high fees that are associated with guaranteed variable annuities (which can exceed 2 or 3 percent each year) can erode returns and increase the risk of wealth depletion in the long run.
IOVAs offer a wide range of investment options, including both conventional investment portfolios and some that are not widely available to average clients—often, "alternative" investments, such as real estate, commodities and hedge fund options. The use of such a wide range of investment options theoretically allows an IOVA to offer downside protection through the use of hedging strategies and diversification.
Further, the product allows clients to invest in alternative investment classes without paying ordinary income taxes or short-term capital gain taxes in the short term, allowing the investment to grow without reduction for taxes (potentially for years). Because of the low fees associated with these products, the tax-deferred growth potential is magnified.
IOVA Candidates and Potential Pitfalls
