If you do some research about variable annuities (herein after referred to as VA’s), you will find it is very easy to find volumes of negative information and press. When you ask most people’s opinion about VA’s, some of the most common responses are; “I don’t like VA’s” or “I’ve heard lots of bad things about VA’s”.
Similar to whole life insurance and reverse mortgages, VA’s are highly controversial products that have always been the subject of great debate. In fact, there are many who passionately proclaim that “nobody should ever own one”.
I believe it is extremely unprofessional for anyone to state that any financial product is always bad. For example, there are some who believe “nobody should ever buy a VA”. If VA’s are really a bad investment for every person, in every situation, then nobody would ever own one – and the VA industry would not exist today.
However, the VA industry is robust and growing, which means people choose them because there is a perceived value. Therefore, in an effort to determine who is a good fit, this article is designed to help debunk the most popular myths and hopefully provide some clarity.
DEBUNKING THE MYTHS OF VA’S
Over the past decade, the amount of money in VA’s has grown to levels greater than any other time in history.
However, this should not necessarily be viewed as good news since VA’s are very complicated and sophisticated products – containing lots of moving parts. Also, given the growing number of VA companies, contracts, and riders, these products are becoming increasingly complex.
As a result, this opens up the opportunity for many challenges for investors. For example, VA’s can be recommended and sold by primarily using the “good soundbites” – versus spending lots of time to review and analyze all of the details. In addition, because these products are so difficult to fully understand, they can be misunderstood, miss-informed, and in some cases, miss-sold.
Therefore, the primary objective of this article is to debunk many of the most common myths that cause many investors and investment professionals to perceive VA’s as a bad investments.
MYTH #1: VA’S HAVE LARGE SURRENDER PENALTIES
It would be far too time consuming to list all of the various surrender penalties within each of the VA companies and contracts. So for the sake of brevity, below are two examples of common surrender period options and penalties:
VA Option 1: 7-Year Surrender Period
An example of 7-year surrender penalties are as follows:
- 7% (Year 1), 7% (Year 2), 6% (Year 3), 6% (Year 4), 5% (Year 5), 4% (Year 6), 3% (Year 7), 0% (Year 8 and beyond)
- This 7-year option usually has lower annual fees
VA Option 2: 4-Year Surrender Period
An example of 4-year surrender penalties are as follows:
- 7% (Year 1), 7% (Year 2), 6% (Year 3), 6% (Year 4), 0% (Year 5 and beyond)
- This 4-year option usually has higher annual fees.
MYTH #2: VA’S “LOCK AND TIE UP” YOUR MONEY
There are many people who believe that when you buy a VA, your money is “locked and tied up”. To some extent, I can understand this argument. However, I believe it is important to address these concerns in depth and debunk this myth.
The VA Suitability Test: Below are the two most important questions for the “annuity suitability test”:
- At the time you plan to start taking income, will your best and worst-case income be enough (and preferably more than enough) to satisfy your needs and objectives?
- Do you have any intention, plan, or need to access large sums of your money in a short period of time? (Not including health, Long-Term Care, or nursing home expenses).
10% of Your Money is Penalty-Free: Every VA contract includes a provision that allows you to access up to 10% of your original investment every calendar year without penalty. This free access provision means you can withdraw up to 10% of your money every year, at any time, for any purpose, and for any reason.
What if You Need to Access More Than 10%? Most VA contracts have surrender penalties if you need to access more than 10% per calendar year in the early years. Therefore, if you need to withdrawal large amounts of money in a short period of time, then a VA is not suitable.
Another important consideration is that if you need to withdraw more than 10% per year (for reasons other than health, Long-Term Care, or nursing home expenses), this withdrawal rate is unsustainable. In other words, no matter what vehicle you choose, taking out more than 10% per year creates an extremely high probability you will run out of money in a short period of time.
What portion of your money is “locked and tied up”? Many people make the argument that VA’s “lock and tie up” your money. In an effort to debunk this myth, let’s review a hypothetical example:
- You decide to invest $1,000,000 into a VA
- Then, for some unexpected and unplanned reasons, you need to access $200,000 in year 4 (not related to health, Long-Term Care, or nursing home expenses)
- At this time, your surrender penalty is 5%
As previously noted, you can access 10% of your money penalty free, which in this case is $100,000. Therefore, the 5% surrender penalty only applies to the additional $100,000 – which in this case would be a $5,000 fee
Here is the “big picture” summary of this particular example. Rather than being able to access 100% of your money penalty-free, you can access 98% ($195,000 versus $200,000).
So for those who believe VA’s “lock and tie up” your money, hopefully this helps to explain why it would be hard to argue that, in this situation, a 2% penalty substantiates the myth that VA’s “lock and tie up” your money.
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