Annuities Explained – Fixed Annuity vs. Variable Annuity
Let’s talk about Fixed Annuities versus variable annuities, which I love to talk about. Now, disclaimer, I don't sell variable annuities. I just don't. You say, "Well, why?" That is a very good question. The reason is I don't sell anything that has the potential to go down. I sell contractual guarantees. You own an annuity for what it will do, not what it might do. Now, I know many people out there that sell variable annuities are going, "Stan, you don't know what you’re talking about. Because the variable annuities are really good." But we're going to talk about variable annuities a little because I know a little about them. Because I used to work with Dean Witter, Morgan Stanley, Paine Webber, and UBS. I even worked in World Trade Center Two South Tower for a while.
All right, I'm going to explain annuities. Who better to explain annuities than America's annuity agent, Stan The Annuity Man. Let's talk about variable annuities. Variable annuities, in essence, in English, in Southern, mutual funds wrapped with an insurance wrapper. And for whatever reason, they don't call them mutual funds in the annuity industry. They call them separate accounts. I will call them mutual funds because guess what? They're mutual funds. That's what they are. Variable annuities sold out in the hinterland are among the most popular annuities. Now, variable annuities were put on the planet in the '50s for tax-deferred growth, and that's fantastic. But what they've turned into, unfortunately, is very high-fee products. Now, the typical variable annuity that an agent sells could have fees ranging from 1 to 4% in that range. And every carrier's different. I know you were saying, "That's a big range." I understand, but I would say that between 2% to 3% typically is what you’ll find with a variable annuity fee for the policy’s life. So every year, you're stuck starting at minus two or minus three, whatever those expenses are.
And a lot of the expenses are hidden. Now, they're not horrible products. I mean, you can attach income riders to variable annuities. We have found that income riders attached to fixed annuities usually offer a higher contractual guarantee. But variable annuities are too good to be a true sales pitch. Market growth, and you can attach guarantees, et cetera. Now there are such things as no-load variable annuities. And once again, disclaimer, I don't sell variable annuities, but I know a lot about them from my previous life. But there are no-load variable annuities, which means that you're liquid on day one and pay a very minor low, low, low fee. Typically, you manage it yourself. Some no-load variable annuities are out there that advisors can manage for a fee. And those are fine. If you're going to say, "Stan, I have to buy a variable annuity," I would say, go buy a no-load variable annuity, and have a professional money manager manage those separate accounts internally for you.
Fixed Annuities, DIAs and QLACs
But once again, there are limitations on the choices. There are limitations on the choices of mutual funds, i.e., separate accounts. Anytime there are limitations, that's not real growth, in my opinion. If you want market growth, buy non-annuity products and go for them. Knock yourself out. But that's my take on variable annuities. Now, fixed annuities. So fixed annuities versus variable annuities. Variable annuities are what they are. But fixed annuities fall into a few categories: Single Premium Immediate Annuities, Deferred Income Annuities, and Qualified Longevity Annuity Contracts are fixed annuities, but those are for a lifetime income. And then you have fixed annuities for principal protection like indexed annuities, and then Multi-Year Guarantee Annuities, i.e., Fixed Annuities. I mean, those are the different types. So it's hard to compare one Fixed Annuity, an immediate annuity, to a variable annuity because an immediate annuity's are for a lifetime income.
A variable annuity could be for growth or should be for growth, supposed growth, or limited growth, okay? Same thing to the Deferred Income Annuity and Qualified Longevity Annuity Contract. Those are annuitized products for a lifetime income. Those are pension products. Those are transfer risk products that will pay you or pay you and a spouse for as long as you are breathing. But I think that the better correlation for me to compare is looking at the fixed index annuity and the Multi-Year Guarantee Annuity, which by the way, are issued at the state level. And those are CD-type products in normal CD worlds, that 2 to 4% range. And then you have variable annuities; we don't know what the guarantees will be. We know you're buying these mutual funds, i.e., separate accounts, for possible growth. So if you compare index annuities MYGAs to variable annuities, variable annuities, there's a downside and an upside. With fixed index annuities and Multi-Year Guarantee Annuities, no downside and limited upside.
What Are You Looking to Achieve?
So it comes down to what you're trying to achieve. Now, the problem we're running into in the industry is that the indexed annuity sales pitch sounds eerily like the variable annuity sales pitch but with principal protection. And you're out there going, "Wait, that's exactly what I want, Stan The Annuity Man. That's exactly the product I was looking for. Market growth, principal protection, locked-in gains. Index annuities are CD products issued at the state level. Okay? Period. End of story. They were put on the planet in 1995 to compete with normal CD rates. And in this world, normal MYGA fixed rates. That's the kind of 2 to 4% world you're looking at.
And there are a lot of people that call me, and I got a call the other day, this is a great example. Guy calls me, saying, "I bought the index annuity sales pitch. The guy said I was going to get 6 to 9% returns. I'm in year three and averaged 1.9% in a raging bull market." And I'm like, "Well, the good news is you're never going to lose money. And that 1.9% was locked in every year, and it's never going to go below that, et cetera." And he was mad. He was upset. Let's just say that. And so I was like, "There's not much you can do because it was a 10-year product on the index annuity, which means there are surrender charges."
And I always tell people with index annuities that have the one-year call option, and you buy a 10-year surrender charge product, you're buying a one-year guarantee with a 10-year surrender charge. So, in this case, you're talking about market growth, the variable annuity's got to win because you can change those mutual funds with most of these variable annuities at your discretion, or they give you some pretty good flexibility to change those mutual funds, i.e., separate accounts around. So index annuities versus variable. One's a CD-type product, one's growth, even though the index annuity is mis-sold as kind of a variable, no. The annuity industry's version of a CD is now a Multi-Year Guarantee Annuity, compared to a variable annuity. This is no comparison. You're buying an MYGA, a principal protection product that pays a specific interest rate for a specific period.
2 Questions to Ask Yourself
A variable annuity is a variable annuity. It's not a MYGA, so you can't compare the two. It really comes down to the two questions I always ask people, what do you want the money to do contractually? And when do you want those contractual guarantees to start? That's where fixed annuities come in. We're talking about contracts. If you say, "I want market growth," some people will funnel you to that variable annuity side. I'm going to tell you that in most cases, most, not all, you should not be buying an annuity if you're looking for market growth. Do variable annuities fit in a 5 to 6% solution-type world where 95% of the people don't need it, but maybe there are five that do under a specific circumstance? Yeah, that's a yes in Southern, yeah. But I'm not a huge, huge fan right now of variable annuities.
Hopefully, that will change because the industry will make some changes. I see some innovative products coming for the registered investment advisor in the variable annuity world, and I'm going to wait and see how that all shakes out.
Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.