Like any financial tool, a variable annuity can be a great addition to your client's portfolio. Used properly, it can help manage the amount of taxes they're paying on your money while also providing growth and security for their retirement years. There are some nuances, however, that you may not be aware of. Here are some questions you should ask about any VA contract your clients are considering, or possibly those that they already have from prior advisors.
1. How much is deducted in fees per year?
Variable annuities, unlike the fixed variety, are a security, and money placed into them will in some form be invested into the market via a subaccount, which typically mirrors an existing mutual fund.
Just like a mutual fund, those subaccounts have annual fees attached to them. A typical variable annuity will also include other fees, such as M&E expenses. Any riders granting additional benefits may carry fees as well. Not all of these expenses are always outlined clearly in the contract and may only be listed in the prospectus — a dense, lengthy document that can be daunting to read.
All told, these fees average out in the 3 to 4 percent range on most contracts, meaning that a year when the contract gains 8 percent — a pretty good year by most standards — only nets a gain of 4-5 percent.
While this doesn't mean that the VA is a bad choice, be sure to add up all of the fees being deducted each year so that you have a realistic expectation for the contract value.
2. How long is the surrender?
At first blush, this may seem like an obvious subject to cover. However, with variable annuities, unlike the fixed variety, you have a bit more freedom in how long the contract's surrender period will be. This is because, among other things, while fixed annuities are ultimately tied to the same market forces as other safe vehicles such as bonds, the subaccounts in variable annuities are much more varied. This results in far more options available to you, namely much shorter surrenders than are typically found in the fixed world.
By choosing a shorter contract, you can keep the option open to move the money later on if your client's needs change or the market changes — this mobility can be a big factor in an annuity purchase, and one we'll talk about more a bit later on.
It is even possible, in certain cases, to obtain a variable annuity contract that does not include a surrender charge at all! This mostly eliminates the main obstacle to most annuity purchases: the worry that the client will need the money before the surrender period ends, and be forced to take a loss due to the penalty. In turn, this gives you more freedom to focus on what matters most, which is choosing a contract that will offer the greatest benefit over the long haul.
Of course, surrender-free contracts are not the norm, and in most cases you will have some period of time where a full withdrawal carries penalties. Check out all the options available before making a decision.
3. Will I be able to move this money?
A dramatic drop in the market will have an equally dramatic effect on the value of your contract. Naturally, your account value will fall, but the repercussions go beyond that. This has to do with the prevalence of income riders, also known as guaranteed minimum withdrawal benefits (GMWBs).
A large portion of the thousands of VA contracts purchased every month carry an income rider — an added benefit that provides a separate "account" that will increase at a guaranteed rate every year, and can never fall due to market performance. The exact percentage of VAs with this type of rider varies a bit depending on the source, but is generally agreed to be well over half; they are a fairly ubiquitous feature. When a lifetime income stream is activated, this income account is used to determine the size of the scheduled withdrawal.
If a large market drop occurs, the account value may fall dramatically, but the income account will remain where it is. Should you ever decide that you want to give up the contract and move the money elsewhere, you may find that your rider prevents you from doing so. This is for suitability reasons — a receiving company will be very unlikely to accept funds that come as a result of the client "giving up" a large income account, even if you submit a statement that they no longer want it. Markets can change a lot over a period of years, and this could mean that your clients are now in a contract that isn't the most beneficial option available.
