Variable AnnuitIES

Defined

Although variable annuities have become highly complex financial instruments with an almost never-ending list of options, fundamentally they are quite simple.  Forgetting the technical aspects for a moment, just think of stocks and bonds.  Now, think of adding a professional manager to decide which ones to buy and sell.  That would be a mutual fund.  Now, put that mutual fund (and maybe as many as 90 others) inside an annuity, so that there are no taxes due until there is a distribution—maybe years down the road.  That’s a variable annuity.

In actuality, a variable annuity does not have mutual funds as investment options, but rather separate accounts, or sub-accounts, as they are referred to sometimes. For our purposes, though, think of them as you would mutual funds. There are usually between 50 and 90 different sub-account options, representing all of the major asset classes, and managed by the same managers you recognize as managing mutual funds.

In recent years, variable annuities have run into some serious challenges by the financial media and self-proclaimed financial experts, because of their higher expenses.  This criticism is justified if there is no real reason for a financial advisor to recommend a variable annuity instead of mutual funds. 

Generally, variable annuities carry a “management and expense” charge, ranging anywhere from 6/10ths of one percent to as high as 1.4%.  This expense covers a number of items, especially the standard death benefit guarantee.  The criticism is based on the presumption that the financial advisor recommends the higher cost product to his client only because he receives a higher commission than he would have had the investor purchased mutual funds.

However, this criticism may boomerang back to point out the ignorance of the accuser.  In one situation, a self-proclaimed, book-selling financial expert was on her television program deriding the egregious expenses of variable annuities and admonishing her dutiful listeners never to purchase one. 

She then took a call from a lady who went on to explain how she was so very thankful that her now deceased husband had the foresight and prudence to invest in a variable annuity.  It seems that he had invested an initial sum of $300,000, only to watch the stock market go down and erode his account value to just over $200,000.  While the account was down, he passed away.  Instead of receiving a check from a mutual fund for the reduced account value, she received a check from a mutual fund for the reduced account value, she received a check from the variable annuity insurance company for the full $300,000.  At that, the caller hung up and our financial guru was speechless. 

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