Variable Annuity Questions Answered

By Melissa Gannon
March 11, 2009

Whether pushy sales agents or unknowledgable customers are more to blame is a matter of opinion. What is certain, however, is that this market downturn has been a dose of tough love for millions of annuity holders.

Variable annuities are insurance products that allow holders to save for retirement. The tax-deferred return on the investment fluctuates with the performance of the underlying investments in separate account funds, sometimes called investment portfolios or subaccounts.

Those who bought variable annuities to meet specific needs with guaranteed results are feeling like kings of the world right now. They have been mostly insulated from the market downturn. These are the folks whose guarantees are at the heart of problems for companies like Hartford Financial (HIG), Lincoln Financial (LNC) and Prudential (PRU).

But those -- and there are millions of them -- who bought variable annuities based on unrealistic expectations/promises of market returns with no guarantees are devastated.

First, it is necessary to explain a fundamental principal of variable annuities: The difference between the account value and the guaranteed withdrawal benefit value of the contract. The account value is the amount that you initially deposited plus or minus any earnings or losses from the underlying investments. After subtracting any surrender charges, this is the amount you get if you surrender the policy. The guaranteed withdrawal benefit value is different. It is the amount you initially deposited plus the guaranteed annual crediting rate. This amount cannot be withdrawn in a lump sum; it is the value from which guaranteed annual benefits are paid to you over time. Many people do not understand this distinction.

Who Has Been Insulated?

Variable annuity holders that are best positioned during this extreme market downturn are those with:

  • a) a guaranteed withdrawal benefit who can withdraw 5% to 7% per year for life regardless of market performance
  • b) that do not rely on income from the variable annuity above that 5% to 7%. For these folks, the account value, which fluctuates with market performance, is irrelevant. The withdrawal benefit could increase above the stated amount if the market increases, but that should be considered icing on the cake.

"It has always been the case, but this market downturn proves that no one should ever buy a variable annuity without some kind of guaranteed withdrawal benefit," stated Randy Shine, a fee-based certified financial planner with Shine Financial in Deerfield Beach, Fla. Otherwise, they are entirely at the mercy of market performance.

One unfortunate aspect is that the vast majority of people don't understand the meaning of the guaranteed withdrawal benefit value -- the amount that has grown each year by the 5% to 7% guaranteed rate.

"Eight of the 10 people who call our office asking for advice don't understand what they have," said Ken Nuss, CEO and founder of "They believe that the guaranteed benefit value can be withdrawn in a lump sum."

These annuity investors want to withdraw this amount, but can't, he said. Instead, if they need all the cash now, they can only withdraw the account value which is down roughly 40% in the past year, he explained.

Who Has Been Hurt the Most?

On the contrary, people who own a variable annuity with no guaranteed withdrawal benefit who are in the accumulation phase of their contract, have been hurt the most. The drastic downturn in the market has essentially wiped out all of their accumulated earnings from the past several years, or even more if the annuity is only a couple of years old.

According to Nuss, the most unfortunate of this group are those already in retirement or within a year or two of retiring who planned to use the variable annuity proceeds to live on. They simply don't have the time to make up the loss.

Even worse, are those folks who purchased a variable annuity expecting to earn a certain amount each year while also withdrawing from it. In many cases, the agent sold these variable annuities on the assumption that the average gains would significantly outpace the percentage being withdrawn. Those folks are essentially reverse dollar-cost averaging by withdrawing as the market declines, meaning that they are accelerating the decline in their account value.

Why Buy a Variable Annuity Now?

Nuss and Shine both agree that variable annuities can still serve a purpose in retirement planning. If you have a specific need that can be met by the features of a particular variable annuity, then you should consider one even in this uncertain market.

Avoiding taxes, however, shouldn't be one of those reasons, explained Shine. Income and capital gains taxes are historically very low. Why would you defer taxes now only to pay them later when they could very well be higher? Don't let the tax tail wag the dog.

A guaranteed lifetime withdrawal benefit might be a reason to buy one. An increasing death benefit offered on some policies may be another reason to buy one.

Are Variable Annuities Safe?

Now, more than ever, it is very important to buy your annuity from a financially sound company. If the insurance company fails during the accumulation phase of the annuity or while you are taking a guaranteed income benefit, you will receive your account value, because it is in a segregated account that has nothing to do with the general accounts of the company.

If, however, you are in the annuitization phase of the contract, your assets have been moved to the general accounts of the company, and you are just like any other policyholder. What you get back is subject to the limits of the guaranty association, which varies by state. You should always check the financial strength of the insurance company selling the annuity.

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