The Truth Behind Variable Annuities: Knowing What You Are Guaranteed

In an increasingly complex world of investment offerings and financial products, it can often be difficult to determine what is or is not a good deal.  For example, suppose someone told you that they could offer you an investment which could do the following:

  • Avoid stock market volatility
  • Earn a guaranteed return of between 5 and 7 percent
  • Possibly earn an even higher rate

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For most people, this sounds like a fantastic product.  However, as the saying goes, anything that seems too good to be true probably is.  Before proceeding, it is prudent to question how someone could guarantee such a high return, particularly in the current low interest rate environment.


In the above article, Moshe Milevsky provides great insight into how people selling “guaranteed lifetime income benefit” variable annuity (GLiB VA) products make the above claims but, in fact, are not telling the whole story.  The return they emphasize in their pitch does not provide an apples-to-apples comparison to investment returns.

A GLiB VA can be broken down into two parts – a guaranteed growth factor and a guaranteed withdrawal factor.  For example, one policy might have a 7% guaranteed growth factor over 10 years and a 5% guaranteed withdrawal factor.  What this means is that if you were to buy a $100,000 variable annuity policy at the age of 55, it will grow by 7% each year and you will have at least $196,715 at the age of 65 (if it is compounded and does not use simple interest).  The investment balance is placed in investment subaccounts, which generally can be allocated according to your preferences (from a list of available choices).  If the investment subaccounts do better than 7%, you will earn that instead, but that probably is less likely, as your realized returns would be net of any management fees by the insurance company.

You will then be able to take out 5% of the above value for life, or put another way, you will receive $9,836 for life ($196,715 x 0.05).  It expires when you pass away (or when the insurance company can no longer meet its obligations).  You may be wondering why over $9,000 a year for an entire lifetime might be a bad deal.  To give this context, we can compare the cost of a single premium income annuity (SPIA).  The SPIA would act as a pension that pays that same $9,836 for life.  Today, it would cost about $139,952 for a 65 year old male or $150,237 for a 65 year old female.  To make this annuity value comparable to an investment return, we can run a calculation that tells us the embedded investment return on an annuity that is worth $196,715 after 10 years.

What is the equivalent investment return for a 65 year old male? A measly 3.4%.

You are earning 3.4% for a “guaranteed” rate, which is only as good as the financial strength of the insurance company selling you the GLiB VA.  The guaranteed growth factor and guaranteed withdrawal factor will vary between policies, but in all cases the rates proudly published in marketing materials are far from what you think you are actually receiving.  Consider a balanced portfolio of stocks and bonds – using historical returns, it is expected that you could earn far more than 3.4% annually over a 10+ year period, even in difficult market periods.  In addition to a return which has been historically much higher, you still have access to your money if you were to need it for an emergency, whereas money tied up in an insurance product is highly illiquid.

If you are considering an annuity, give us a call.  We would be happy to crunch the numbers and give you the rate of return you can easily compare to an investment portfolio, as well as discuss whether or not annuities are an optimal strategy for your financial situation.