We have all heard about, hopefully prepared for, and are thriving in the wave of economic opportunity presented by the baby boomers. When you couple the financial goals of boomers with the risks of volatile equity markets, increased life expectancy, and lack of defined benefit retirement plans, you will find out why variable annuities are one investment option that requires a closer examination. There is no denying that the variable annuity industry seems to have re-branded itself from what was once primarily thought of as an accumulation vehicle to what is now considered one of the go-to choices for distribution planning.
However, are we limiting our target market by only considering those 50 and older? Can variable annuities appeal to younger clients, and should they be considered a go-to product when planning for Generation X-ers? A quick inventory of the pros and cons commonly associated with variable annuities may help shed some light on the subject.
The benefits
At the heart of every variable annuity is tax deferral. Annuity gains are taxed as ordinary income upon distribution, as opposed to other investments that may be taxed as long-term capital gains. However, if the client doesn't plan on taking distributions for more than 20 years, clearly there is more than adequate time for the tax deferral to outweigh the difference between these tax treatments. Also, nobody knows where the capital gains tax rate will be in the long run, anyway.
Very comprehensive investment profiles are driving the better variable annuity choices available today. These portfolios typically cover every asset class imaginable, while some even offer opportunities to invest in specific sectors and ETFs. Clearly these are not your father's old variable annuities with limited investment options.
Is this a good fit?
Are these vast choices and options good for younger investors? Perhaps. Take a look at typical holding periods for the average mutual fund investor today. Most investors typically liquidate their mutual fund holdings every three to four years, which means taxes if you sell at a gain, potential expenses associated with the new investment, and the possibility of getting out of the market at exactly the wrong time. However, with variable annuities, our clients are able to move among the sub-account choices available while not incurring the taxes and fees that may be associated with changing from mutual fund to mutual fund. There are also myriad guarantees available.
These guarantees do come at a cost, however -- and indeed, one of the biggest perceived negatives surrounding variable annuities is cost. Yet different guarantees mean more options, which are almost always attractive to clients. Plus, most of the living benefit guarantees available today are optional, and if the client does not want one, they can simply not select the guarantee and forego this cost. At a minimum, the contract is going to provide a basic death benefit -- and even young clients with young families can die unexpectedly. Variable annuities don't necessarily compete with life insurance for family protection, but you do see the death benefit on many variable annuities come into play for beneficiaries who would have otherwise received the market value of their stock or mutual fund portfolios if the market were down.
No one investment is right for every client. It also would not be prudent to suggest that a variable annuity is a preferred method of saving over a qualified retirement plan. However, if you are fortunate enough to work with younger clients who are making a good living, you will find they will need alternatives to invest in a comfortable retirement. Perhaps some of those savings will come from stocks and mutual funds and maybe even real estate and life insurance. If you are not considering variable annuities because of the perception of tax inefficiencies, costs, or even lack of liquidity, you may be missing an opportunity to round out your client's holdings.
Robert G. Alvarez, CFP is president of GunnAllen Insurance. For more information, call 800-809-5402 ext. 2290 or email ralvarez@gunnallen.com.
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