How to Find the Best Variable Annuities

Variable annuities have been making a comeback in recent years. This is due, in part, to the improved performance of the markets, but much of the resurgence can also be attributed to the renewed spotlight on some of the guarantee features that many shell-shocked investors desperately seek. Couple that with the fact that the variable annuity space has become much more competitive driving down expenses and fees while their benefits have been greatly enhanced. For investors, it is good news all around, so it may be good to time to explore how to find the best variable annuities.

Variable Annuity Comparative Features

When comparing variable annuities, it is important to remember that they are a multifaceted investment vehicle wrapped inside of a contract which actually becomes an obligation of a life insurance company. Unlike a fixed annuity, in which your funds are comingled with the general investment account of the life insurer, a variable annuity has separate sub-accounts consisting of various investment portfolios that enable you to determine how your funds will be invested. You can allocate your funds among a family of professionally managed stock, bond, fixed yield, or real estate funds, much like you can with a family of mutual funds.

That’s where the direct comparison with mutual funds stops. One of the primary differentiators of variable annuities is their favorable tax treatment that allows all of the earnings inside the sub-accounts to grow tax deferred. Although they ultimately are taxed as ordinary income upon their withdrawal, they will be left unencumbered by taxes for many years which means faster accumulation. Additionally, variable annuities include a death benefit which, in effect, guarantees that your beneficiary will receive no less than your original investment (less any withdrawals).

As variable annuities evolved, so did their features, benefits and guarantees. Newer contracts include features or options that beef up the guarantees that, effectively, minimizes the risks associated with investing in the financial markets. While some of these additional guarantees come at an additional cost, the premium investors pay for these protections may very well be worth the peace-of-mind that they bring.

Comparing Investment Sub-Accounts

As with mutual funds, comparing the historical performance of the sub-accounts is one way to separate the best variable annuities from the rest. Investment pros will caution you, however, that past performance is no indication of future performance, and so simply comparing past returns is not likely to give you the complete picture you need.

A stronger indicator of good professional management is its consistency in outperforming the major indexes. Managers who do a good job, year-end and year-out beating the market indexes, even if by a small margin, may be better in the long run, than managers who get big returns for a couple of years, but then underperform the market in bad years. The better managers find a way beat the market indexes in down years as well.

All of the information on historical performance, fund managers and fund objectives can be found in the prospectus that must accompany any discussion of the product with a financial professional.

Comparing Fees and Expenses

Next to fund performance, the fees and expenses of variable annuities garner the most attention. This is due to the fact that, over the years, variable annuity expenses have been criticized as being too high, at least as compared to mutual funds. It’s somewhat of an apples and oranges comparison because of the additional features and benefits offered through variable annuities.

They both share an expense known as a management fee which covers the cost of professional investment management of the funds. For most investors, the lower the management fee, the better, however, some well-managed funds may warrant a higher fee if it has demonstrated consistent returns over the years. These fees can range from .25% to 1.25% depending on the type of fund. Aggressive stock funds are more actively managed, so their fees tend to be higher (but so are their potential returns).

Variable annuities charge an additional fee to cover mortality costs which provides the death benefit guarantee. Most variable annuities also include an administrative fee to cover the costs of record keeping and other administrative functions. These fees can vary widely as well; however, mortality costs tend to fall into the 1% range.

Account Access

With variable annuities you do have access to your account values, but with some limitations. The contract includes a surrender period, during which you may withdraw up to 10% of your account value without a surrender charge. Any excess funds withdrawn are charge a surrender fee which can be as high as 12% in the first year. The fee is reduced by one percentage point each year of the surrender period until it vanishes, which, essentially ends the surrender period.

Both the surrender period and the surrender fee are also competitive features that should be compared. For the most part, the shorter the surrender period is, and the lower the fee, then the better the product, perhaps. It would be important to make sure that a variable annuity with a highly attractive surrender feature isn’t offsetting that with higher expenses elsewhere.

Minimum Guarantees

Although an investment in variable annuity sub-accounts involves risk due to fluctuating market prices, variable annuity contracts come with some guarantees that can reduce or even eliminate the risk. For instance, the death benefit guarantee ensures that your beneficiary will receive at least the principle investment at your death. Some contracts have a step-up valuation, as an option, which continuously ratchets up the death benefit amount to include the gains in the sub-accounts.

Additionally, some variable annuities offer an option that will ensure that you receive a minimum return on your account value even if they decline due to a decline in the markets. The minimum rate guarantee is an option with a charge, but it may a good risk reduction premium to pay. More variable annuity contracts are offering this as standard feature. For any options, it is important to weigh their costs against the potential benefits.

To Find the Best, Look to the Top

All of the guarantees and protections provided in variable annuities are backed by the issuing life insurance company, so it is important to consider only those companies in the best financial condition. Life insurers are rated for their financial strength and ability to pay all of their obligations. For the greatest peace of mind, it may be best to look for the best variable annuities among the top rated companies.