Variable annuities have long been the
of investments because of their relatively high cost to consumers.
But as low-cost money managers such as
take on the insurance companies that dominate the field, costs are inching down and annuities are slowly shedding their black helmets.
The average annuity's expense ratio is 2.09%, according to
, down from 2.11% in 1997. But that small drop doesn't reflect other changes that are making annuities easier to own.
For example, TIAA-CREF, the giant teachers' pension system, is rolling out a variable annuity this month that is available to investors -- teachers and nonteachers alike -- for as little as $250. Most companies today demand at least $2,500 for new accounts. Other providers have jettisoned annoyances such as surrender fees for early withdrawal. Still, others are piling on new options, such as a guarantee that you'll take out no less than what the portfolio was worth at its highest point.
Experts say costs should continue falling as direct-sellers -- primarily no-load mutual fund companies such as
T. Rowe Price
and Vanguard, and online-only providers such as
-- expand their now-tiny share of the market.
Meanwhile, annuities sold by intermediaries -- mainly insurance agents and stockbrokers -- still accounted for about 97% of the roughly $100 billion of annuities sold in 1998, according to
Variable Annuity Research Data Service
The shift toward direct-sold annuities is slow, partly because of the attitudes of the sellers. Rather than emphasizing annuities' advantages, low-cost direct sellers tend to emphatically state in their sales literature who should
Many brokers, on the other hand, are looking for reasons to sell this product featuring commissions that are doubly sweet compared with, say, those of stock trades, says Gordon K. Williamson, a San Diego-based financial planner and author of
Getting Started in Annuities
"Annuities are sold, not bought. And the big driver of sales is commissions,'' Williamson says.
And that leads many experts to question whether lower fees will, in the short run, lead to significantly higher sales for direct-sellers. Though the cost of owning an annuity has fallen, it remains high compared with the 1.37% average expense ratio for a stock mutual fund.
Mutual Fund Wrapped in an Insurance Policy
Stripped down to its basic moving parts, a variable annuity is an IRA-based mutual fund wrapped inside an insurance policy that can pay a guaranteed income stream or a death benefit. Some variable annuities offer a choice of as many as 30 mutual funds, known as "sub-accounts," while others offer only a single fund option.
As is the case with nondeductible IRAs, money placed in a variable annuity is allowed to grow without taxes on capital gains or dividends. Yet unlike IRAs -- or 401(k) plans for that matter -- there are no investment limits. In any given year, you can invest as little as $250 or as much as $2.5 million. Annuity holders can begin tapping into this money when they turn 59 1/2; withdrawals can begin sooner for those willing to pay a premature withdrawal penalty of 10%.
The "guaranteed lifetime income stream" is a key selling feature with variable annuities. Take a 70-year-old man who accumulates $50,000 in a variable annuity. Should he choose to "annuitize'' -- or take systematic payments for the rest of his life -- he can receive somewhere between $350 to $400 monthly, no matter how long he lives.
Though the lifetime income guarantee sounds like an unbeatable deal, insurers can calculate it with overoptimistic assumptions about your life span and underoptimistic assumptions about the earning power of your money. Most people are better off keeping their money in growth mutual funds and municipal bonds, Williamson says.
Planners who disdain annuities do so for three reasons. Operating fees are high and capital gains accumulated over the life of an annuity are taxed as regular income rather than at the preferential capital gains rate. Also, bequeathed annuities are taxed based on their value when originally purchased -- an expensive proposition for investments held many years. Stocks and mutual funds passed on to heirs, on the other hand, are assumed to have been purchased at the time of the bequest.
Guaranteed Income a Key Feature
Still, variable annuities continue to sell well "because people are looking for guaranteed sources of income,'' says Colin Devine, a
Salomon Smith Barney
analyst who covers the life insurance industry. Many companies have dropped traditional pension plans, which workers have long depended on to supplement monthly
checks. Many people, as a result, are looking for guarantees that their lives will not outlast their money, Devine says.
To grant those wishes for security, insurers -- in exchange for additional fees -- have piled on new features. Some offer annuities that protect policyholders against inflation. Some offer protection against market risk. Some offer long-term health-care insurance. These, and other features, carry costs and benefits -- and a vocabulary that's Chinese to most laymen.
That strange vocabulary, say analysts, will also keep variable annuity sales in the hands of brokers and agents. Though it's now possible for
to mention price-to-earnings ratios in TV commercials -- a term beyond the reach of most viewers just 15 years ago -- most viewers would draw a blank if they were to hear "life income with period certain." (Annuity payments that continue for the life of the policyholder. If the policyholder dies before the time period spelled out in the contract, then the payments are made to a beneficiary.)
Few resources are yet available to translate this vocabulary to English. The Internet, aside from
www.insure.com, has few educational resources that are not commercially driven.
Only when more buyers master the arcane vocabulary will they feel confident enough to buy variable annuities on their own, analysts say.
Matthew Lubanko writes about personal finance and property and casualty insurance for the
Hartford Courant. He welcomes your feedback at
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