Debunking Variable Annuity “Improvements”
AO = Advisor Overheard. That’s me. VA = Variable Annuity Wholesaler. For those of you outside of the industry, the insurance companies that make products like variable annuities have their own sales staff who push the product to the real salespeople, the Financial Advisor / Planner community. Annuities are an important part of the planning arsenal, but in the end, insurance is insurance. You pay for some form of protection and that’s that. In exchange for your money, the insurance company offers you some future benefit, which in this case is a stream of lifetime income. Creative marketing, complexity, and the fees everyone collects along the way take over from there. You can learn about the product itself here or here if you need some background.
VA: Hi, AO, do you have a moment? I wanted to tell you about the improvements and adjustments we recently made to our variable annuity contract.
AO: Hi VA – thanks for keeping me posted. Let me guess, you’re cutting the withdrawal rates? These low long term yields have got to be brutal on your underwriting…
VA: Well, actually we are raising our guaranteed withdrawal amounts. That’s the improvement I am calling to tell you about.
AO: OK, I am onto your game, so then what did you do to your guaranteed growth rate?
VA: You always are keeping me on my toes AO. We have reduced that. But here’s the thing. We’ve gone from 10% down to 7%, simple interest for as long as 10 years garaunteed growth, BUT, like I said, we’ve actually raised the gauranteed mininum withdrawal amount from 4.75% up to 5%. So pending how you look at it, that’s still a pretty good deal.
AO: Improvement implies I get more though – those numbers tell me I get less. By I, I mean my client of course.
VA: Well you do get more on the withdrawal side, you are right that you get less though on our guaranteed growth benefit.
AO: But THAT is exactly the problem. You can’t seperate the two. For sake of the insurance contract, they are truly inseperable. Listen, tell me what you’d prefer. Option A is I could give you a 3% growth rate per year, simple interest, with a 6.75% withdrawal rate, Option B is a 7% growth rate, so way higher growth, with a 5% withdrawal rate, which is not that much less. Option C, this is the crazy stuff, is I’ll give you a 14% garaunteed growth rate, but a 3.5% withdrawal rate. Comparing A to C, A has over 5 times the growth rate for just over half the withdrawal rate. You’d take C, right?
VA: Okay, yes – but I get the feeling I’m being setup…
AO: Damn straight you are! This is “Figures Lie and Liars Figure 101.”
VA: This is why you don’t give me more business?
AO: Don’t knock me off of my soapbox yet. So in A, if you’ve got $100,000 to start with, that’s going to generate $3,000 a year for let’s use the industry standard of 10 years before you can start taking withdrawals. Simple interest gets us to $130,000. 6.75% of $130,000 is $8775 of income per year. Option B – same $100,000 to start, grows to $170,000 and taking it out at 5% gives you… drum roll please… $8,500 per year. Finally, good old amazing option C grows to $240,000 and pays out a whopping $8,400 per year.
VA: I see your point.
AO: You just can’t seperate these two numbers.
VA: So because I know you have work to do – let me just say, our benefits are lower than where they used to be.
AO: Speak the truth brother. Low interest rates are killing savers, and they aren’t helping you out here.
VA: Anything you need, just call.
AO: Thanks VA.
Please notice that I didn’t touch on the actual costs of a VA contract or any of the other ugly stuff. If you’re not familiar with annuities read the links mentioned above. I’ll tear through the product in a client annuity review post in the near future. There’s also a good article from Linda Stern at Reuter’s that at least says your old annuity might be worth keeping because of those promised benefits from days of higher withdrawal rates. She’s on the right path.