Simpler Variable Annuities Could Play A Big Role In Retirement Planning
June 18, 2018 by Jamie Hopkins
A secure retirement plan needs secure income sources. But figuring out how to sustain an income stream throughout retirement relies on an important component: having adequate savings to begin with.
For more and more Americans, annuities are part of the solution for growth and income. Certain annuities, like fixed annuities, can be used to replace bonds as a source of secure retirement income, while variable annuities can provide potential growth upside as well as optional income. However, there is still no consensus around the best way to incorporate annuities into a retirement plan.
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Now, while the role of fixed annuities in a retirement income plan as a potential bond or CD replacement has been gaining traction, when it comes to variable annuities there is much more serious debate in the financial services profession about their role in a plan. Recent years have seen contraction in the variable annuity market. What was once a $100 billion annual market has been declining the last few years as the income benefits of the product have been reduced and relatively few consumers choose to take advantage of the income option.
But recent reticence associated with variable annuities may now be changing. For example, New York Life, a leader in the insurance and investments business, reports growing traction around a variable annuity designed to simplify the offering without compromising the benefits of potential growth. Dylan Huang, senior vice president and head of retail annuities at New York Life, explained their approach:
“While we believe the ultimate way to secure retirement is through a guaranteed lifetime stream of income, we also recognize that not everyone is ready for income planning. Instead, they prefer to focus on growing their nest egg. These folks tend to dial down their equity exposure due to fear of loss. Driven by these worried savers, we’ve seen growth in our variable annuity with an optional accumulation benefit rider, which offers 100% protection of principal in case of a market slide, with uncapped growth potential.”
Variable annuities can offer a lot of flexibility and benefits to a retirement plan. Let’s take a quick look at potential benefits:
- Growth potential: Variable annuities allow savers to stay invested in the market. For those in their fifties and sixties, this can be a critical time period when they still need to find some nest egg growth but feel compelled to cut down on risk at the same time.
- Tax benefits: Variable annuities are tax-deferred investment vehicles. This means you do not pay taxes on the investment income and gains inside the annuity until the money is withdrawn. It also allows you to transfer money between investment options within the annuity without triggering income taxes.
- Downside protection: Variable annuities can offer two forms of downside protection. First, if the consumer dies before payments begin, the annuity can provide a death benefit to an heir. Second, a variable annuity allows the policyholder to be invested in mutual funds, stocks, and other investment instruments without losing money if there is a significant market drop. In other words, some variable annuities can give consumers the courage they need to stay in the markets, even when the going gets rough.
- Guaranteed income riders: A variety of riders can be attached to variable annuities for a fee. There are riders that will guarantee a lifetime withdrawal benefit amount if certain contract requirements are followed, while other riders can guarantee a future minimum account balance. These riders can help provide income that is otherwise unavailable when investing directly into mutual funds or equities.
- Behavioral finance benefits: Many investors engage in “panic selling” when markets go down. Selling investments and trying to market time during periods of market volatility tends to result in worse performance than staying the course. While variable annuities can still lose value in market declines, retirees do not have to “panic sell” because of the downside protections, riders and benefits that are available in the annuity which can lessen the pain of a market downturn.
While there are a number of benefits to variable annuities it is also important to understand some of the drawbacks and issues to review before making a purchase. First, because variable annuities are long-term investment products, taking early withdrawals can subject the investor to penalty fees and taxes. Additionally, surrendering the annuity during a surrender charge period can result in huge charges to the account value. As such, investors do give up some liquidity when investing in a variable annuity.
Additionally, a number of other fees and expenses are likely associated with the annuity. Make sure you fully understand the cost of the annuity before making a purchase. Lastly, remember that this is still an investment product so there is some market risk associated with the variable annuity, even if it is not to the same degree as a direct market investment.
Variable annuities can play a role in a comprehensive retirement plan if the benefits and costs are clearly identified. However, today it can be challenging to fully understand both the positives and drawbacks of investing in a variable annuity. It is crucial that variable annuities are viewed as long-term investments and not as short term tax or investment planning vehicles. Clearly, some of the latest product redesigns and simplified offerings could go a long way to clarifying the role that variable annuities can play in a retirement plan.
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