by Matthew Grove
Consumer advocates question the high costs and steep commissions of traditional variable annuities. But with pension plans declining and social security's future unknown, it's time for VAs to get back to basics: simple, low-cost tax-deferral that lets clients save more than their IRA or 401(k) while securing an income stream for retirement. We take a closer look at one of the newest innovations—the first VA with a flat insurance fee.
There is almost no cost to providing tax deferral. But when it comes to variable annuities, most consumers pay a steep price.
As of December 31, 2005, Morningstar estimates more than $1.2 trillion is invested in VAs, and average insurance charges are 1.35% per year. That's at least $15 billion each year in insurance fees alone. Add on asset-based fees for complicated riders, and costs quickly escalate.
Now, there's a solution: A brand new category of flat-fee VAs that provides simple low-cost tax deferral, without the expensive—and often unnecessary—bells and whistles.
New Category: No fat. Just flat
VA critics are irate. "You rarely find me so deeply angry at a common investment product that I dream of blowing it to smithereens," Jane Bryant Quinn wrote in Newsweek on August 30, 2004. And in her recent best seller, Suze Ormon says, "Actually, I don't dislike VAs, I hate them. Here's why: They are really expensive...You are pushing 3 percent a year in various fees. That's ridiculous."
Flat-fee VAs eliminate asset-based insurance fees, commissions and surrender charges and replace unwanted fat with one flat insurance fee, no matter how much clients invest. Instead of complex riders, flat-fee VAs offer hundreds more investment options, letting you maximize performance with a mix of standard and esoteric alternatives, such as commodities, real estate and hedge-like funds.
How does a flat fee stack up? All VAs will charge fees of underlying funds and any investment advisor hired. As for insurance fees, based on Morningstar's industry average of 1.35%, a typical $100,000 VA contract costs $1,350 per year in insurance fees alone. A $1 million VA costs $13,500. A flat insurance fee can be as low as $20 per month—just $240 per year in insurance fees—regardless of account size. A considerable savings.
Flat Breaks Rank: New Distribution
Then there's the issue of sales tactics. In the Wall Street Journal on October 20, 2004, Jonathan Clements wrote, "Variable annuities are a favorite with unscrupulous investment advisers, who can collect ridiculously high commissions by foisting these turkeys onto unsuspecting investors." The result? As VA sales grow, so do complaints. According to the NASD as of July 31, 2006, annuity cases are consistently the third most common type of securities arbitration, behind stock and mutual funds.
Flat-fee VAs break rank with products designed for fee-only and fee-based advisors. By stripping out commissions, flat-fee VAs eliminate conflict of interest. By eradicating all asset-based insurance charges, flat-fee VAs let you provide substantial cost savings for clients, while earning a fee for managing assets inside the annuity.
Flat is Powerful: Upside for you and your clients
Investors come out ahead with flat-fee VAs. Lower costs let them save more money, grow principal faster, and defer more taxes until after retirement—when many are in a lower tax bracket.
Flat-fee VAs offer special benefits for "tax-inefficient" investments, such as REITs, bonds, and actively managed stock funds that generate short-term capital gains and ordinary income, taxed as high as 35 percent. Based on a recent study by William Reichenstein, finance professor at Baylor University, these investments consistently perform better in a low-cost VA than in a taxable account.
And the upside for advisors? Instead of giving up 1.35% or more to the annuity company each year, the flat-fee savings means improved performance for your firm. A considerable benefit in this secular bear market.
Flat is Revolutionary
The time is right for a flat-fee revolution. Roughly 76 million boomers are nearing retirement. With pension plans rapidly declining and Social Security's uncertain future, consumers need better options to save substantially more than their IRA or 401(k), and the means to secure an income stream for retirement. Flat-fee VAs are a powerful tool to accomplish both. So, get on board now, or wait for the world to change around you.