The new variables in variable annuities

For some clients, increased flexibility in variable annuity contracts can be a positive — these contracts may provide clients with the opportunity to take higher withdrawals earlier in retirement (reducing the payouts once the account value is depleted) in order to manage sequence of return risk associated with traditional retirement accounts and investments. 

Sequence of return risk is a market volatility risk surrounding the order in which returns on a client's investments occur. Essentially, if a greater proportion of low or negative returns occur during the early years of retirement, the client's overall returns are going to be lower than if those negative or low returns occurred at a later point in the client's (and the investment's) lifetime. If the client has the ability to allow those investments to continue growing because he or she can take higher withdrawals from a variable annuity contract, the risk is mitigated.

For other clients, however, an annuity carrier's ability to change product terms based on market performance can actually make the products less valuable. Many clients purchase variable annuities (rather than investing directly in the equity markets) in order to mitigate the risk of market downturns. For these clients, reductions in value of the contract guarantees (or increases in fees) based on market performance may eliminate the appeal of the variable annuity strategy.

Additionally, clients who purchase variable annuities to protect against the risk of outliving other assets may find these products less attractive, because their value is more likely to be reduced later in life if the annuity account value is depleted — at the same time that traditional retirement assets may also be dwindling.

Conclusion

Many clients have become accustomed to changes in the variable annuity industry in recent years — but in the case of products that can alter the value of guarantees over time, it becomes more important than ever for advisors to evaluate the client's overall goals and financial position when recommending these new variable annuities.

Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.    

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