Variable Annuity Comparison
Much time and effort has been spent comparing variable annuities with other financial instruments - particularly mutual funds, which they closely resemble. Much less time has been devoted to comparing variable annuities with each other. Presumably, this is because the mistake of choosing the wrong asset is adjudged more serious than the mistake of picking the wrong asset vendor. Accepting this logic does not negate the value of a variable annuity comparison between companies. Variable annuities are not a homogeneous class. The differences between variable annuities make comparison worthwhile.
Points of Variable Annuity Comparison
A list of key points of variable annuity comparison would include the following:
Variable annuities are often criticized for their high expenses. In addition to the expense of managing the sub-accounts (each of which is, for all intents and purposes, equivalent to a mutual fund), there are the expenses of administering the insurance features of the fund and setting up and operating the sub-accounts. The internal expenses are usually listed under the heading of “Mortality and Expense Charges.” Certain companies are known for their low-cost mutual funds. These same companies can be a good place to shop for low-cost annuities.
Although frequent trading in sub-accounts is unlikely to produce superior returns, proper asset allocation requires “rebalancing” of portfolios to maintain the proper percentage allocations among asset classes. Some variable annuities limit the annual number of free trades that can be executed in the sub-accounts. All other things equal, the fewer such limitations, the better.
Today’s variable annuities often feature riders that guarantee certain minimum levels of income and allowed withdrawals. A guarantee is only as good as the assets that underwrite it. Many insurance companies today are backing away from promises made to variable annuityholders. The stronger the company, the less this is likely to happen.
With a gigantic universe of financial products to choose from, there is no reason to choose a variable annuity with unattractive investment alternatives. Careful shopping among variable annuities should yield one with a serviceable menu of choices.
Different variable annuities offer different insurance-related benefits. The most prominent of these is the death benefit, which can be calculated in ways ranging from simple to complex. Since the insurance benefits account for a substantial fraction of the variable annuity’s cost, it makes sense to get the benefits (if any) that you want.
These are additions to the standard policy that are necessary to accommodate individual preferences. The best examples today are the “Living Benefit” riders that provide guarantees of minimum income, withdrawals and rate of return. Because a standard contract can’t include everything of potential value to everybody, this is the way to achieve alterations tailored to the annuityholder’s particular tastes and preferences.
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Ironically, this is probably the most common basis for comparison, but it may be the most overrated. The saying “past performance is not guarantee of future returns” is not mere legal boilerplate. A past history of good returns is no inoculation against future underperformance. The best reason for picking a variable annuity with a good investment track record is probably psychological; picking a variable annuity with a mediocre historical performance would probably lead to self-recriminations later if the annuity performed badly.
This is another misunderstood element of variable annuities. This product often provides high commissions to sales people. The issue is not necessarily the existence or magnitude of sales commissions. Rather, the important thing is to find out whether the benefits you derive from the sales process compensate you for the costs.
Consider an illustrative example. Some financial planners who represent companies will provide a full financial plan to their customers. This is potentially a huge benefit to the investor, worth a sales commission and then some if done competently. On the other hand, a different salesperson might do little more to earn the commission than take your order.
Variable annuities generate sales commissions because somebody has to explain the workings of the annuity to relatively unsophisticated customers and that person must be paid for their work. Moreover, there are ample opportunities to provide valuable service after the variable annuity is purchased. Contrary to popular opinion, there is nothing untoward, fraudulent or exploitative about a sales commission. It is, however, a cost that should have a correlative benefit. A comparison might well uncover large differences between different variable annuities, not only in the size of the commission but also in the service provided (if any).
Comparisons between variable annuities are not nearly as numerous as comparisons between variable annuities and alternative investment products. There are good reasons for this, but the fact remains that comparison between different variable annuity products can yield substantial benefits. The most important comparison point is probably the expenses charged to the annuityholder. Low-cost variable annuities do exist; the best place to look for them is probably at the same companies that provide low-cost mutual funds.
The least beneficial comparison point may be the most highly stressed among non-professionals – investment performance. There is little reason to think that most portfolio managers can consistently beat the market averages, so the purpose of this comparison is more for psychological reassurance than anything else.
The overriding purpose behind comparison is to weigh costs and benefits. Many variable annuity costs are disregarded by investors obsessed with market yield, while some of the biggest potential benefits are not even contemplated. One such benefit is the financial planning and customer service provided by sales personnel in exchange for commissions.
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