What Every Retirement Saver Needs to Know About Variable Annuities
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today we are talking variable annuities. Insurance products are great and all, but this confusing product was charging my client $15,000 per year in hidden fees for benefits that she didn't even need.

If you own a variable annuity or you've considered purchasing one to save for retirement, today's episode is for you. For all the links and resources mentioned, head over to youstaywealthy.com forward slash 63. There are two basic types of annuities, deferred and immediate.

A variable annuity, the annuity that we're talking about today, is a type of deferred annuity. And with a deferred annuity, you put money in, you give the money time to grow, and then you use the dollars to help fund retirement at a later date. I usually say 10 plus years down the road. So what exactly is a variable annuity? Here's my simplest explanation.

If you took a diversified portfolio of mutual funds, you added a small tax benefit, and then you wrapped everything up in an insurance policy, you would essentially have a variable annuity. That's pretty much it. Those are the three parts that make up a variable annuity. One, a basket of mutual funds.

Two, a tax benefit. And then three, insurance. Now, the diversified portfolio of mutual funds is pretty simple to understand. Those don't look any different than what you might find in your 401k at work, let's say. Just a plain old list of stock and bond mutual funds to choose from.

And the tax benefit, the second component is pretty easy to understand too. Like a 401k or an IRA, the money inside of a variable annuity grows tax deferred year after year. In other words, you don't pay annual taxes on dividends and interest or capital gains. It's all deferred until you go to take money out in the future, right?

When you take money out, your earnings inside the variable annuity above and beyond your initial investment are taxed.

Now, exactly how the earnings are taxed depends on the withdrawal option you choose at that time. And for today, I'm just going to leave it at that. So just know that your variable annuity operates just like your 401k or IRA. It's tax deferred. When you go to take money out, you're going to pay taxes on those earnings.

What's not so easy to understand is the insurance policy that wraps all of this up and turns it into a variable annuity. But really quick, before we get there, there's one major pitfall that I want you to watch out for. When you put money in a variable annuity, you do have the option to invest with pre-tax dollars like a traditional IRA or with after-tax dollars like money in your brokerage account or even your checking or savings account at the bank.

I just told you a minute ago that a variable annuity is a tax deferred savings vehicle.

A traditional IRA is also a tax-deferred savings vehicle. Therefore, there really isn't a rational reason why you would invest traditional IRA dollars into a variable annuity. You're paying extra fees to get a tax benefit that you essentially already have. You're putting a tax-deferred account inside of a tax-deferred account.

Yes, you get the insurance policy that comes along with it and it'll be up to you to decide if you think the insurance benefits are worth it or not. So that's what I want to focus on. I want to focus on the insurance policy and the benefits and then let you decide. There are two main things I want you to know about the insurance component of a traditional variable annuity that a salesperson might try and sneak by you.

Number one is the guarantees. So this is a common word that you're going to hear in the variable annuity retirement world. The two most common guarantees you might be intrigued by are one, a guaranteed rate of return. In other words, the insurance person might try to tell you that your annuity is guaranteed to grow by X percent per year, no matter what the market does.

The second thing or the second common guarantee you might come across is the ability to lock in gains and create a floor for your investments. In other words, if your account value reaches a new high in a given month or a given quarter or even year, you might be told that your new account value, your new higher account value is now locked in and it can never go below that amount in the future, even if the market tanks.

Now, these two guarantees, if they exist in the contract that you own or you're considering, are not lies, but there is a common misunderstanding.

The guarantees really only impact the insurance portion of your contract and will really only come into play if you annuitize your contract in retirement and you use it to provide you with retirement income. They're often referred to, and you can look through your statement, they're often referred to as living benefits.

And you might see the specific guarantees labeled as guaranteed minimum accumulation benefits or something like guaranteed minimum withdrawal benefits.

And to me, and this is just my personal opinion, to me, they're just this kind of like phantom benefit or phantom guarantee that they're essentially built into the economics of the entire policy. They sound great, but the benefits are just built into the economics of the entire policy so that the insurance company can kind of control all the risk here. If you ever wanted to cancel your contract,

and take your money out and invest it someplace else, those guarantees are not applied. Even if you invested in this thing for 10 years, those guarantees are not applied if you want to take your money and run. The insurance company will give you a check for whatever your mutual funds are worth at that time. Meaning, if you put $100,000 into a variable annuity with these fancy guaranteed accumulation benefits...

and the stock market was going through a downturn and the market value of your variable annuities mutual funds are now worth, let's say, $80,000, then $80,000 is what you can walk away with minus, of course, any fees that they might apply on your way out there. It's really no different than you investing in similar funds outside of a variable annuity.

Owning these mutual funds inside of a variable annuity doesn't make them any less risky. A variable annuity allows you to buy some certainty around future income, but it's not this riskless product and it's not any less risky than investing in stocks and bonds and in any other type of account. So

In summary, just be certain to dig deep and understanding exactly what these guarantees are and what they apply to. When in doubt, my favorite question to ask really is,

What if I want to take my money out and run in one year or three years or five years or 10 years? Show me what that scenario looks like. What am I entitled to withdraw upon the cancellation of my contract? And then most importantly, what are the fees to do that? If you ask those questions, you're going to learn a lot about these policies.

Speaking of fees, that's the second thing that I wanted to touch on regarding the insurance component of these variable annuities. As mentioned, variable annuities are insurance policies and buying insurance, as you guys know, costs money.

every single guarantee, every benefit that you might see attached to a variable annuity is something that you're going to be paying for. Nothing's free. Nobody is giving you all these great bells and whistles and downside protection, inflation protection, and guaranteed rates of returns, all this stuff. No one's giving you these things for nothing. So any benefit that you see on an advertisement that somebody is telling you, any of these benefits you are paying for is

Here are just a few of the fees, the few of the things that you're going to be paying for if you open up your variable annuity and look under the hood. Mortality and expense risk fee, administrative fee, annual contract fee, advisor fee, mutual fund expense fee, surrender fee, and then rider fees. And there could be dozens of rider fees.

It wouldn't be uncommon to add up all these fees and see something that's charging you 3% or more per year. That means that if you invested $100,000 into the variable annuity, you could be paying $3,000 per year for benefits that you may or may not need.

My client that I mentioned at the beginning of the show had $500,000 invested in a variable annuity that was costing them close to that 3% number or $15,000 per year. And to make matters worse, that $500,000 was invested using traditional IRA dollars, a tax deferred account inside of a tax deferred account paying $15,000 per year for insurance guarantees that they did not need. This

This policy, if you're wondering, was sold to them after the 08-09 crisis when everyone was panicked and it was positioned as this low risk investment option, but that's not what it was. This is not what they needed. Now, what I just spoke about applies to traditional variable annuity contracts, the type of contract where you get the hard sell from a commissioned advisor or an insurance salesperson.

If someone starts rattling off guarantees and this downside protection and low risk, and it just starts to sound too good to be true, you're probably looking at one of these expensive traditional contracts. But there are actually some really good low cost variable annuities that have come out recently that strip out all of this nonsense. You essentially get the benefits of tax deferral

but none of the insurance guarantees that most people really don't need anyways, or there's cheaper ways to get those guarantees. There are dozens of these low cost variable annuities out there, but the three that I'm most familiar with, and I'll link to in the show notes, again, the show notes are at youstaywealthy.com forward slash 63. The three that I'm most familiar with, and I'll link to one, the Fidelity Personal Retirement Annuity.

to the Schwab Retirement Income Variable Annuity. And then three, there's a variable annuity offered by Nationwide called Nationwide Monument. These low-cost annuities that do a good job of stripping out all of the insurance nonsense can potentially be great savings tools for retirement if, and this is a big if,

If all of your other retirement accounts are fully maxed out, if you are regularly maxing out every other tax favored retirement account and you want to save additional dollars for retirement, you might consider a low cost variable annuity like one of the three I just mentioned. And again, there are dozens more out there. You can do your homework.

The cost shouldn't exceed about a half a percent per year. So 50 basis points per year all in, and that would include the mutual fund expense ratios. And even then, you do need to understand the benefits of those added costs and if they make sense. So be sure to run some numbers to see if the cost for buying the long-term tax deferral truly makes sense versus just investing in a plain vanilla brokerage account.

Also, you're going to want to understand what the limitations are if you ever have to withdraw money from these contracts sooner than planned.

One last thing. The great thing about annuities, specifically variable annuities, is that they can be exchanged from one company and product to another. However, the annuity has to be out of what's called surrender or you're going to pay some really hefty surrender fees. So before you just hurry up and jump to exchange this crappy high cost annuity that you have into one of these lower cost options, be sure to call your current, your existing annuity company and ask them what annuity

If any, surrender fees will be applied because even if you don't cancel it and you exchange it or transfer it, those surrender fees, if they exist, will still be applied. And again, they can be really expensive, like tens of thousands of dollars sometimes. So be sure to call your existing annuity company and play out some of those scenarios before you go and do that.

If you need help, this is our expertise. And my firm currently has capacity to take on 10 new clients in 2020. If you want to explore working with us and you want to talk more about maybe some of the variable annuities that you own currently, just shoot me an email at podcast at youstaywealthy.com. There's no pressure, no obligation. I'm just letting you know that we're here, that we exist if you need us. Thank you as always for listening and I'll see you back here in two weeks.

Hey, it's me again. I just wanted to say thank you one more time for listening and remind you to please, please, please leave a quick review. If you're on an iPhone, leave a quick review on iTunes. If you're enjoying the show, I'm getting great feedback from listeners just like you. And I really want to keep the momentum going. So if you have a chance on your iPhone, leave a quick review on the Apple podcast app. And thank you so much in advance for all of your help and support.

This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services. ♪