The Roth IRA has boosted interest in retirement savings across-the-board, and variable annuity sellers want a piece of the action.
Trouble is, say financial advisers, annuities aren’t appropriate investments for individual retirement accounts, despite the fact that investors have been funding their traditional IRAs with variable annuities for years.
Variable annuities’ main selling point is that they allow investors to invest tax deferred, and investors pay a premium to get it. But “qualified” retirement plans such as IRAs and 401(k)s offer a similar tax shield, so investors get next to nothing for the extra fees they pay, according to Glenn Daily, a fee-only insurance consultant in New York.
“I don’t know anybody who would say it’s good to have a variable annuity inside a qualified plan, other than the people who sell them,” Daily says. Annuity sellers are only courting the Roth IRA market “because that’s where the money’s going right now.”
Linda Zurkowski, assistant vice president and director of education for Wood Logan & Associates, a Greenwich, Conn., firm that brokers sales of annuities for Manufacturers Life Insurance Co., admits her industry is “responding to a very large public hype around this type of plan.”
Annuity sellers also concede that their product’s most attractive feature goes to waste inside an IRA structure. But they say their product offers more than tax deferral to make it a worthy vehicle for the Roth IRA, such as their less-discussed insurance features. Variable annuities are essentially mutual funds inside an insurance wrapper.
For instance, there’s the “death benefit,” which guarantees an annuity holder’s heirs will receive at least the principal should the holder die during a market downturn. Some sellers say the death benefit brings enough peace of mind to investors to merit the 1.1 percent mortality and expense risk charge, or M&E fee, to compensate for the death benefit–a fee not included in mutual funds, the more conventional vehicle for the Roth IRA.
Thomas Mitchell, a consulting actuary for Aurora Consulting Inc. in St. Louis, estimates that the average death benefit is actually worth a negligible 0.10 percent to 0.25 percent of assets. He also finds it “peculiar” that M&E fees don’t vary based on age or health because they surely factor in to the value of such a benefit.
Another justification is the “annuitization,” feature, a method of guaranteeing an income stream from an annuity by arranging distributions as lifelong, monthly or quarterly payments. Although not yet a popular feature with investors, annuitization differentiates variable annuities from their mutual-fund brethren and is quickly becoming a key secondary selling point for the products.
“What the variable annuity provides that other investments don’t is the ability to elect to receive a lifetime stream of income, which is what you want when you retire,” says Mark Mackey, president and chief executive officer of the National Association of Variable Annuities, a trade group that has publicly defended funding qualified retirement plans with annuities.
Funding a Roth IRA with a variable annuity invites many complications because both the annuity policies and the Roth tax rules apply. Investors may withdraw a certain amount of money tax-free from a Roth IRA after five years. But it’s not that simple with annuities, which usually charge a so-called surrender fee for money pulled out in the first seven years. So a withdrawal from a Roth annuity between the fifth and seventh years would incur a penalty after all.
“Boy, you had better believe these things are complex,” observes Bill Knox, a tax and estate-planning lawyer at Warren, N.J., law firm Herold and Haines. “So it’s investor beware.”
Northwestern Mutual Life Insurance Co. in Milwaukee, which has sold 16 million variable annuities within the Roth IRA so far, plans to rev up its Roth IRA promotion. It is mailing literature to all its annuity holders promoting variable-annuity use with an IRA.
As to criticism on pairing IRAs and annuities, Meridee Maynard, a Northwestern vice president, says: “You have to look beyond tax deferral. There are other product features that are valuable.”
Maynard says low-fee variable annuities are appropriate for IRAs because they compensate for the unused tax deferral by charging less. Northwestern’s variable annuities that charge an upfront sales charge have total expenses ranging between 0.61 percent and 1.10 percent, which is competitive with many mutual funds.
However, not every annuity seller agrees that variable annuities and the Roth IRA should mix. Some, such as Variable Annuity Life Insurance Co., are offering, but not pushing, the Roth for annuities. Vanguard Group, the mutual-fund firm whose annuity fees are among the lowest in the business, is taking that a step further. The Malvern, Pa., company won’t even sell annuities for IRAs.
“The main benefit of variable annuities is the ability to achieve tax deferral in an investment program,” says Joel Dickson, a senior investment analyst and Vanguard’s Roth IRA point man. “Why would you pay extra cost to achieve extra tax deferral when you already have it?”
