AssetBuilder Inc. Registered Investment Advisor - Simple Investing. Smart Future.

After thousands of authored articles on how expensive variable annuities are compared to simply purchasing index funds I am amazed that no one seems to address the real issue.  No one is ever going to argue that you will make more money in an index fund than you would in a variable annuity- if you invest in the same index fund. 

 The arguement holds no value unless every fund returned the same return.  Then you compare fees and of course pick the low cost index fund.  But that world does not exist. 

 Furthermore people continue to ignore the reason for the billions of retirement dollars going into variable annuities.  The Living Benefits.  WIth the Death of the Pension Funds people want security.  Most people retiring with a 401k have all their money in the secured fixed account. 

I know this is difficult to believe not only by the smart readers such as yourselves but aparently by every financial author ever comparing index funds to variable annuities, but not everyone has the stomach for the stock market.  That is why study after study shows that investor behavior significantly affects investor performance.  If every investor would buy and hold and stay in the market there would be no place for the Variable Annuity.  With longevity risk, inflation risk in retirement the investor with $300k in their 401k sitting in the fixed account needs some solution.  A variable annuity with a living benefit and a gauaranteed 5% for life payout or whatever the living benefit is today is a viable solution for obviously billions of retirement dollars. 

 If these people would invest in the market and stay in throughout retirement the variable annuity is of course not a good option for many that understand and stay in the market.  For most people this is simply not the case and the variable annuity is replacing the large group pensions.  There are even 401k's out there today that allow people close to retirement to transfer money into a variable annuity with a living benefit inside the 401k. 

The simple comparison of fees is too basic and obvious of an approach to say what investment is right or wrong.  My point in this is to investigate a little further and understand why the variable annuity is being utilized.  Who knows- If our Fed Chairmans largest asset is in a VA and millions of others own them with living benefits maybe we are a society of idiots? 

Or is something else going on?  I just wish more people would look at things more objectively and not with such conformed biases when they write articles to advise the public.

mcampbell,

The "living benefits" options in variable annuity contracts are relatively new. Only a handful of companies offered them as recently as 2000 but, for the reasons you cited, they have been wildly successful since then. Today, according to the National Association for Variable Annuities, 85 percent of all variable annuities have living benefits provisions.

These provisions, however, raise the cost of variable annuity contracts even more. They can exceed 3.00 percent a year. Add that to a 5 percent withdrawal rate and the upside potential of your investment is extremely limited.

Worse, while these contracts can be made to appear that you have great value--- with riders like Guaranteed Accumulation--- when you do an financial analysis having such riders basically allows you to receive about 62 cents of benefit for each $1 you give the insurance company.

A column on this subject is scheduled for this coming Sunday. In the meantime, here is a column from last year that took a similar analysis path: http://assetbuilder.com/blogs/scott_burns/archive/2007/11/02/magic-in-finance-part-2-an-alternative-to-living-benefits.aspx

It is important that you note that my better solution involves the purchase of another insurance product, an immediate life-annuity. I have nothing against insurance products per se. I just want them to work for the buyer and variable annuities very consistently provide no value to the buyer and lots of compensation for the sales force.

Scott