Common “Misconceptions” About Variable Annuities
Last week, I came across this publication (opens pdf in new window) put together by the Association For Insured Retirement Solutions (Hmmm, I wonder if they have an agenda?) rebutting what they call common “misconceptions” about variable annuities. According to their website, this association (called NAVA),
“…is a proven, highly-effective alliance of leading companies involved in the annuity and variable products industry.”
As you might have guessed, the points they attempt to discredit are generally spot-on but unfortunately, their rebuttals may seem logical to an overly-trusting investor. To keep things balanced, I’ve prepared a rebuttal to several of their rebuttals. The supposed “misconceptions” are in bold, followed by their rebuttal in plain text and my comments in block quote.
“Myth”: Variable annuities cost too much; far more than mutual funds.
While there are additional charges associated with a variable annuity, these charges are used to pay for insurance benefits that are not available with other investment products.
These benefits include
- Beneficiary protection through a guaranteed death benefit;
“Me: True, but ordinary, simple term life insurance accomplishes the same goal for a lower price. All trying this benefit up in an annuity does is add complexity to your life.”
- The ability to participate in the stock market with principal protection
“Me: If only that were true. This particular product, commonly called Equity-Indexed Annuities, promises to give you the return of the stock market in up years but protect you from down years. Unfortunately, these products are universally so complicated and riddled with fees you’ll be lucky to match bond market returns over the long run, much less stock market returns. The downfalls of these products are well-known so I won’t repeat them here, but think of it this way: the relationship between risk and return is very persistent. If these products actually offered stock-market returns without the risk, don’t you think everybody would buy them? No fancy insurance product can change the fundamental relationship between risk and return: you can’t get stock market returns without stock market risk.”
- The option to receive retirement income payments guaranteed to last a lifetime
”Me: There is absolutely nothing preventing you from using part or all of your portfolio to purchase an income annuity at retirement, effectively accomplishing the same thing. Thus, a variable annuity doesn’t give you any options you wouldn’t have anyway. Since a they don’t offer any additional benefits, it makes you wonder just what exactly you’re paying all those extra fees for.”
“Myth”: Mutual funds are a better investment than variable annuities because earnings are taxed at capital gains rates.
Changes in the tax law in 2004 did not significantly benefit many mutual funds which are managed for total return, not tax efficiency. In other words, these funds don’t base their buy/sell decisions on whether gains are short or long term. Short-term gains are taxed at ordinary income tax rates. According to Morningstar, Inc., the average annual mutual fund turnover rate in 2003 was 91%.
“Me: That’s not an apples-to-apples comparison. Sure, if an investor picked the absolute worst mutual fund available and the absolute best variable annuity available, the annuity just might come out ahead. But that’s not realistic. In real life, there are a ton of inexpensive, low-turnover mutual funds to choose from and of course, there are always index funds. A broadly-diversified stock index fund is practically guaranteed to beat any variable annuity on both a pre- and after-tax basis.”