There are three types of deferred annuities for investors to choose from in order of least to most risk: fixed, fixed-indexed, and variable. Variable accounts are most risky as they are directly tied to the ups and downs of the overall stock market which is why you you see variable annuity complaints.
In an attempt to lessen the risk of investment loss associated with variable annuities, many insurance companies now offer guaranteed death benefit and/or a living income benefit riders. It is important to understand how these riders can affect future account values and withdraw options.
Death benefits were the norm in most annuity contracts over the last decade or so. Annuitants paid a small fee each year and in turn were offered a guaranteed death benefit that would equal a predetermined growth or accumulation value in the annuity policy. These are sometime referred to as “high water-mark” contracts.
The problem is the stock market has been extremely volatile over the last decade and this volatility appears to be an increasing trend. There have been at least two significant economic downturns that caused precipitous drops in all of the major market indexes. This caused several variable annuity contracts to have a significantly higher death benefit (high water mark) than living benefit (walk away value) for the owner.
In reality, what started as an annuity account quickly turned into a life insurance contract due to a substantially higher death benefit. Most annuities were worth more to the owner at passing than during his or her lifetime. That might be acceptable if policyholders were only concerned about their heirs, but that is usually not the case or life insurance would have been purchased in the first place.
Furthermore, when withdraws were taken from the account either through required minimum distributions or for living expenses, then the leveraged death benefit would decrease in kind. In this way, many variable annuity owners were stuck with a confusing, hard-to-value investment.
Variable annuity policyholders might be hesitant to cash in their account for fear of losing the higher value that might be passed on to their beneficiaries at passing. At the same time, they wanted an investment that was more predictable and less volatile. Those competing needs simply did not allow for enough investment flexibility and choice.
As oppose to a life insurance rider that provides a potentially higher contract value at death, this living benefit provides a guaranteed income stream to the annuity owner for a predetermined period of time – usually life.
In this way, there are two values at play. The actual value of the contract (subject to market fluctuations) that allows the owner to walk away at the end of the term; and the second value or lifetime income value if the contract is later annuitized.
The lifetime income account value increases each year by a predetermined amount (6% for example) and costs a few basis points to the owner each year – perhaps 1/2 of one percent. Thus, if and when the market collapses, the income account value will be much higher than the walk away value.
In order to withdraw the maximum from the annuity, the owner must annuitize the contract over his or her lifetime and has in essence purchased a future income stream, but not a deferred annuity. If a future income stream was needed, then there are safer annuities offering such guarantees.
Just like the guaranteed death benefit, the living benefit rider causes the variable annuity to morph into a different type of investment or what is commonly referred to as an immediate annuity. And just like the former, the owner may feel they are stuck with an investment they did not originally purchase.
The insurance company can guarantee a 6% step-up each year on the income account value because of the yearly charge and the fact that they will control all deposited funds for the life of the owner. Insurance companies will make some of their money back during the lifetime payout process.
Of course, there is nothing that prevents owners from transferring the deferred variable annuity contract to a safer investment at the end of or during the investment term. When the income or death benefit account value is much higher than the walk away value however, this can be a very difficult choice to make.
It is human nature to try and obtain the most value from any investment. Thus, many investors who own variable annuities end up holding them beyond the original term – longer than they anticipated when the account was originally funded. And too often the investor is disappointed in the market performance which caused the annuity to become something other than for what it may have been intended.
For those who are looking for an opportunity to exit an under-performing variable annuity, there are viable options. Both fixed and equity-indexed annuities offer safety, security and predictable future growth. But most importantly, the owners can walk away with all accumulated funds at the end of the term. There is no fear of giving up possible gains by losing out on a death benefit or lifetime income rider.
Several insurance companies offer fixed indexed annuities with reasonable potential for returns, up front premium bonuses, and the ability to lock gains in each year. The up front premium bonus can help offset the loss of principal in a variable annuity. Additionally, transfers can be done without incurring income taxes should the older annuity have eked out any gains.
Hyers and Associates is an independent agency marketing fixed and fixed indexed annuities throughout the country. Should you own an under-performing variable account and are in need of advice or an exit strategy, we can help make a suitable recommendation. Contact us today!