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I'm happy to agree that VAs are not good products for most people. But while I like Scott Burns, this article is filled with distortions and half-truths.
"[A] death benefit ... guarantees that your designated beneficiaries will get your original investment, even if the value of the investment has declined."
Not necessarily. All policies (I believe) must have a death benefit to be qualified as insurance. But that death benefit can be as simple as promising to pay your beneficiaries the current value of the underlying portfolio. For example, by default Vanguard offers what it calls an "Accumulated Value Option" for its death benefit. The traditional death benefit that Burns is referring to, Vanguard calls "Return of Premium Option", and Vanguard adds 0.2% to the cost for this option. TIAA-CREF similarly offers a barebones return of premium death benefit as default and offers the return of premium option for 10 basis points extra. Fidelity used to offer a VA with return of premium (Retirement Reserves); it cost 55 basis points more than its current annuity offering, Personal Retirement Annuity, that doesn't even come with a return of premium option.
The point is that VA costs don't have to be as high as he's claiming - because he's claiming they have to offer a benefit (return of premium), when they don't. (A second point is that the death benefit is a huge profit add-on for the insurance companies - just compare what Vanguard and TIAA-CREF charge, at cost, vs. what Fidelity charged when it was using it for profit in a "low cost, no load" annuity.)
"A typical variable annuity ... has an average annual insurance cost of about 1% [and] another 0.75% to manage the basic [underlying domestic equity fund. ... As a consequence, the insurance company skims 1.75% or more ..."
I won't harp on his hyperbolic "or more", other than to note that since these are average figures, it could just as easily be "or less". Rather, I want to focus on his blaming the insurance company for "skimming" the whole amount, including the fund management fees. If I buy a fund through a brokerage, the brokerage may or may not charge me some fees, but the money that goes toward managing the fund isn't "skimmed" by the brokerage - it goes to the fund management company. Same here. In fact, Burns forgets to point out that the average (non-dollar weighted) management fee for domestic equities is somewhere around 1%, so you're getting something of a break with VAs, as they tend to use "institutional-like" funds. That doesn't make up for the average wrap fee, but it does mitigate it.
Finally, while he chooses to use "average" cost figures for VAs, he picks index funds (rather than average domestic funds as he did for the VAs), and even among index funds, he picks the cheapest. If he picked the cheapest VAs, with the cheapest death benefits, and the cheapest funds within those VAs, and then considered the fact that the "average" investor sells funds every (what, 2-3 years?), and factors in the tax impact of those trades, he'd come up with some different conclusions, or at least figures that were a lot more honest.
I was also concerned that this article didn't provide the big picture. If I were a professional writer; I surely would have provided as much detail as possible with a full list of the pro's and con's. My write will also not provide the big picture; but there are circumstances and some VA's that may provide another avenue for some investors.
---The tax status is not an invalid consideration, considering an ordinary income tax burden on withdrawals from a VA. A presumption would have to exist indicating that an investor would be able to operate a very tax efficient portfolio outside of the VA shelter to have a lower tax burden. ---Along this same line, the tax burden mentioned regarding lower dividend and captial gains tax rates on non-VA sheltered monies. This may true today, but these tax rates may be gone at the end of this year. True, this is an unknown; but is in place to change. ---As msf noted regarding fees; well, fees may be every which way depending upon what one may desire from a VA. Fidelity offers 54 fund choices within their VA accounts. There may have been some small chances since I reviewed this area last year; but this is a snippet from what I recall from a year ago: One would pay the the expense of whichever fund and an additional .25%. A fund with an ER of .75% added with the VA fee would =1% total fees. Today, with a quick look; I find indicated for the Fidelity funds within the VA to indicate what appears to be a flat fee of .80%. I don't know if this is a change from last year or not; and currently do not have the time for further investigation. Also, with a Fido VA; one is restricted to 4 round trip fund exchanges per year. NOTE: the Fidelity VA account is not an insurance policy type of investment, so does not include an insurance guarantee or related as may be found with traditional VA products issued through a full blown insurance vendor. Also, there is not the traditional penalty period for withdrawals as is common with most VA accounts. So, if one pulls their monies within 1 year, there is not the common 7% penalty fee in place. ---I am not a fan of, or would recommend a traditional VA to many folks; I also am not a tax attorney, so there may be items related to taxes that would have to be sorted out by a professional dealing in taxes.
exactly right Ted and why I still own a VA, in fact added $5000 in Dec. I'm retired, no earned income and will be 78 in a month. Cash in a taxable account earning no interest.
Agree with others that VA should not be used before some other forms of tax-sheltered investments (notably IRAs and defined contribution plans).
Catch - I think that what you were looking at was the older VA that Fidelity used to offer - Retirement Reserves. This had an 80 basis pt wrapper (it was originally 100 basis pts when it firts launched), plus underlying fund fees, and insured return of premium. The current plan, Personal Retirement Annuity, costs 25 basis points plus underlying fund fees. It is still technically insurance, and guarantees return of accumulated value (i.e. what you've currently got in the underlying funds). Now to you and to me, that doesn't sound like any insurance at all, yet it's treated as insurance, and thus regulated on the state level and not by the SEC.
A VA is like a cross between a non-deductible IRA and a 401k plan, taking the worst attributes of both. Like the non-deductible IRA you get no immediate tax benefit, and capital gains are transmuted into ordinary income. Like the 401K, you investment options are limited to what's in the plan. The calculations on whether it pays (after exhausting other options) are very similar to deciding whether a non-deductible IRA makes sense. And the answer is: sometimes, but generally only if you'll have money in it for decades. (Otherwise, the transmutation of cap gains into ordinary income costs more than the tax sheltering saves.)
Finally, note that there's nothing about "variable annuity" that says "deferred". There are immediate VAs, and given the low interest rate environment we're in, might even make more sense than the traditional (fixed) immediate annuity.
Hi msf, I should have had that extra cup of coffee. You are correct. I reversed my fee numbers between the old and new VA accts offered at Fidelity. And has been mentioned, and too which I agree; there may be a place for using the Fido VA's when other avenues are not available. The current list of funds (54) does provide a fairly decent choice of investments. I have not looked at all of the funds for ER; but a quick glance and guess would indicate about a 1% average ER. Our current retirement accts holdings ER average is .70%; and we know there are numerous folks who are paying much higher than 1%, especially if also paying adviser fees. Anyhoo, if I was using the Fido VA; I suppose I would prefer to take my chances of compounding the non-taxed earnings each year; versus the monies being taxed at current rates for cap gains and dividends. Maybe a coin toss for the winning totals at the end, eh? Thank you for your input, msf.
Comments
"[A] death benefit ... guarantees that your designated beneficiaries will get your original investment, even if the value of the investment has declined."
Not necessarily. All policies (I believe) must have a death benefit to be qualified as insurance. But that death benefit can be as simple as promising to pay your beneficiaries the current value of the underlying portfolio. For example, by default Vanguard offers what it calls an "Accumulated Value Option" for its death benefit. The traditional death benefit that Burns is referring to, Vanguard calls "Return of Premium Option", and Vanguard adds 0.2% to the cost for this option. TIAA-CREF similarly offers a barebones return of premium death benefit as default and offers the return of premium option for 10 basis points extra. Fidelity used to offer a VA with return of premium (Retirement Reserves); it cost 55 basis points more than its current annuity offering, Personal Retirement Annuity, that doesn't even come with a return of premium option.
The point is that VA costs don't have to be as high as he's claiming - because he's claiming they have to offer a benefit (return of premium), when they don't. (A second point is that the death benefit is a huge profit add-on for the insurance companies - just compare what Vanguard and TIAA-CREF charge, at cost, vs. what Fidelity charged when it was using it for profit in a "low cost, no load" annuity.)
"A typical variable annuity ... has an average annual insurance cost of about 1% [and] another 0.75% to manage the basic [underlying domestic equity fund. ... As a consequence, the insurance company skims 1.75% or more ..."
I won't harp on his hyperbolic "or more", other than to note that since these are average figures, it could just as easily be "or less". Rather, I want to focus on his blaming the insurance company for "skimming" the whole amount, including the fund management fees. If I buy a fund through a brokerage, the brokerage may or may not charge me some fees, but the money that goes toward managing the fund isn't "skimmed" by the brokerage - it goes to the fund management company. Same here. In fact, Burns forgets to point out that the average (non-dollar weighted) management fee for domestic equities is somewhere around 1%, so you're getting something of a break with VAs, as they tend to use "institutional-like" funds. That doesn't make up for the average wrap fee, but it does mitigate it.
Finally, while he chooses to use "average" cost figures for VAs, he picks index funds (rather than average domestic funds as he did for the VAs), and even among index funds, he picks the cheapest. If he picked the cheapest VAs, with the cheapest death benefits, and the cheapest funds within those VAs, and then considered the fact that the "average" investor sells funds every (what, 2-3 years?), and factors in the tax impact of those trades, he'd come up with some different conclusions, or at least figures that were a lot more honest.
---The tax status is not an invalid consideration, considering an ordinary income tax burden on withdrawals from a VA. A presumption would have to exist indicating that an investor would be able to operate a very tax efficient portfolio outside of the VA shelter to have a lower tax burden.
---Along this same line, the tax burden mentioned regarding lower dividend and captial gains tax rates on non-VA sheltered monies. This may true today, but these tax rates may be gone at the end of this year. True, this is an unknown; but is in place to change.
---As msf noted regarding fees; well, fees may be every which way depending upon what one may desire from a VA. Fidelity offers 54 fund choices within their VA accounts. There may have been some small chances since I reviewed this area last year; but this is a snippet from what I recall from a year ago: One would pay the the expense of whichever fund and an additional .25%. A fund with an ER of .75% added with the VA fee would =1% total fees. Today, with a quick look; I find indicated for the Fidelity funds within the VA to indicate what appears to be a flat fee of .80%. I don't know if this is a change from last year or not; and currently do not have the time for further investigation. Also, with a Fido VA; one is restricted to 4 round trip fund exchanges per year.
NOTE: the Fidelity VA account is not an insurance policy type of investment, so does not include an insurance guarantee or related as may be found with traditional VA products issued through a full blown insurance vendor. Also, there is not the traditional penalty period for withdrawals as is common with most VA accounts. So, if one pulls their monies within 1 year, there is not the common 7% penalty fee in place.
---I am not a fan of, or would recommend a traditional VA to many folks; I also am not a tax attorney, so there may be items related to taxes that would have to be sorted out by a professional dealing in taxes.
Just my inflation adjusted 2 cents worth.
Regards,
Catch
Regards,
Ted
Catch - I think that what you were looking at was the older VA that Fidelity used to offer - Retirement Reserves. This had an 80 basis pt wrapper (it was originally 100 basis pts when it firts launched), plus underlying fund fees, and insured return of premium. The current plan, Personal Retirement Annuity, costs 25 basis points plus underlying fund fees. It is still technically insurance, and guarantees return of accumulated value (i.e. what you've currently got in the underlying funds). Now to you and to me, that doesn't sound like any insurance at all, yet it's treated as insurance, and thus regulated on the state level and not by the SEC.
A VA is like a cross between a non-deductible IRA and a 401k plan, taking the worst attributes of both. Like the non-deductible IRA you get no immediate tax benefit, and capital gains are transmuted into ordinary income. Like the 401K, you investment options are limited to what's in the plan. The calculations on whether it pays (after exhausting other options) are very similar to deciding whether a non-deductible IRA makes sense. And the answer is: sometimes, but generally only if you'll have money in it for decades. (Otherwise, the transmutation of cap gains into ordinary income costs more than the tax sheltering saves.)
Finally, note that there's nothing about "variable annuity" that says "deferred". There are immediate VAs, and given the low interest rate environment we're in, might even make more sense than the traditional (fixed) immediate annuity.
I should have had that extra cup of coffee. You are correct. I reversed my fee numbers between the old and new VA accts offered at Fidelity.
And has been mentioned, and too which I agree; there may be a place for using the Fido VA's when other avenues are not available.
The current list of funds (54) does provide a fairly decent choice of investments.
I have not looked at all of the funds for ER; but a quick glance and guess would indicate about a 1% average ER.
Our current retirement accts holdings ER average is .70%; and we know there are numerous folks who are paying much higher than 1%, especially if also paying adviser fees.
Anyhoo, if I was using the Fido VA; I suppose I would prefer to take my chances of compounding the non-taxed earnings each year; versus the monies being taxed at current rates for cap gains and dividends. Maybe a coin toss for the winning totals at the end, eh?
Thank you for your input, msf.
Regards,
Catch