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Posted: October 12, 2012

The brave new world of variable annuities

This much-maligned investment deserves another look

Aaron Grey and Robert Grey

Variable annuities have had such a bad rap in some financial planning circles that many advisors refuse to discuss them—let alone recommend them for clients. It’s no wonder, because the negative image of variable annuities looks something like this:

Picture a well-intentioned middle-age couple—risk-averse and nervous about saving enough for retirement—who stretch their budget to purchase a high-cost variable annuity with all the bells-and-whistles from a pushy insurance salesman who is paid on commission and has no fiduciary obligation to consider their best interest. Their hard-earned savings become locked up in an inflexible product that eats away at their principle through asset-based fees charged for complex insurance riders that they don’t understand. Eventually, they end up paying a surrender charge that could be as high as 7 percent to exit the policy and regain access to their assets.

Indeed, in our experience as financial advisors, we have seen more than one new client arrive burdened by a high-cost variable annuity that is poorly suited to their personal situation or financial status. It’s no surprise that many consumer advocates have questioned the value of variable annuities and the tactics used to sell them.

But here’s what many investors and their advisors may find surprising: Variable annuities have changed. In fact, more independent Registered Investment Advisors (RIAs) and fee-based financial advisors are recommending this new breed of variable annuities to investors. Here are two big reasons why:

Variable annuities can provide tax-shielding benefits, similar to qualified plans such as 401(k)s and IRAs. That’s especially useful for aggressive savers and high net worth investors who are able to max out contribution limits in a given year. This new breed of low-cost, no-load variable annuities is designed specifically for tax-deferred investing, offering more fund choices, greater transparency and stripping away complex and costly insurance components that investors—and even many advisors—find hard to comprehend.

Still, the subject of variable annuities can get a bit heated. We think a good place to start the conversation is by addressing five common complaints—and what’s changed so that we can confidently recommend VAs that are in our clients’ best interest.

1. Variable annuities are primarily used for the insurance.

In the midst of a “features and benefits arms race” that has gone on for decades, most variable annuities today are sold with additional insurance riders such as income guarantees and enriched death benefits.

But variable annuities were originally designed as a vehicle for tax-deferred savings accumulation. They take advantage of tax code provisions that permit deferred taxation on earnings generated “inside” the product. And this is exactly the focus of a new breed of VAs. Their purpose is not about the insurance—it’s about creating a simple and efficient vehicle for saving money tax-deferred. Research shows that by keeping costs low and eliminating excessive asset-based insurance fees, clients can maximize the benefits of tax deferral to accumulate more for retirement and to generate more retirement income.

And investors do have more cost-effective choices than the insurance riders sold with traditional VAs. To protect against downside risk, now some VAs offer a much broader selection of funds allowing investors  to more accurately match their tolerance for volatility, investment goals and time horizons. To provide a death benefit, many investors can purchase a simple term life policy.

And, while most variable annuities today are still sold by an insurance agent or broker who earns a commission every time they put a client into another new annuity, this new breed of low-cost, no-load VAs are typically recommended by RIAs and other independent fee-only financial advisors who make a fiduciary commitment to their clients.

2. Variable annuities are too expensive.

Many variable annuities continue to be expensive—especially those sold with up-front fees for commissioned sales reps, plus insurance company fees charged as a percent of the assets invested, plus the cost of the investment options inside the VA. The insurance fees alone can range from an average of 1.35% for the basic mortality and expense fees, to as much as 4% per year when various income guarantees are included.

But variable annuities don’t need to be expensive. With this new breed of low-cost VAs, structured solely as a vehicle for tax-deferred savings, investors pay only a modest insurance fee for a tax-deferred wrapper. This insurance fee is typically one-half to one-third the industry average. There is even a flat-fee VA that charges just $240 per year, no matter how much you invest. This new breed of VAs also helps investors save more by stripping away the up-front sales fees that would be paid to a commissioned insurance agent. Vanguard, TIAA-CREF, Jefferson National, and others offer these low-cost, no-load products.

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Robert Grey AIF® is the founder of Denver Money Manager. Since 1984 he has been at the forefront of the maturation of the fee-for-service financial planning and investment management industries. Rob's experience in the financial services industry spans over 30 years, and includes the areas of banking, insurance, and investments.

Since 2003, Aaron Grey has working as a fiduciary financial advisor for his clients at Denver Money Manager LLC.  Aaron is a Certified Financial Planner™ and holds a BS in Chemical Engineering from the University of Colorado. The Denver Money Manager Advisory Team specializes in integrated financial planning and investment management; taking a holistic view of a client's entire financial life to develop a cohesive blueprint designed to allow them to experience “Financial Serenity.” Contact Aaron at or 303-675-6771.

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