Variable Annuity Sales Alive and Well in 2nd Quarter, Despite Predictions of Their Demise

Old conventional wisdom: Variable annuity sales are doomed, thanks in part to reductions in the capital gains tax and the advent of the Roth IRA.

New conventional wisdom: These often-maligned retirement accounts are alive and well, thanks in part to the Roth.

Americans purchased a record $27.1 billion in variable annuity contracts during the second quarter of this year, according to figures released Thursday by the Variable Annuity Research and Data Service, in Marietta, Ga.

That represents a 17% increase from the previous quarter and a 27% increase over the second quarter of 1997. For the first half of this year, sales are up 20% versus the first two quarters of 1997.

Sales of variable annuities--tax-deferred mutual fund-like investments that are wrapped in a layer of insurance--are on pace to break last year’s record of $87.7 billion.

The only obstacle appears to be the prospect of a sustained bear market, says Rick Carey, editor and publisher of the VARDS Report.

If the stock market rebounds quickly, he thinks the industry could hit $100 billion in sales, as aging baby boomers begin to think hard about their retirement savings.

As recently as last year, the financial planning community had predicted the first real slowdown in variable annuity sales since 1988, when total sales for the industry were $7.2 billion.

Retirement experts based this on two developments: 1) the creation of the Roth IRA, a retirement account which, unlike variable annuities, allows owners to withdraw their money tax-free after accumulation; and 2) the Taxpayer’s Relief Act of 1997, which cut the long-term capital gains tax rate to 20% from 28%.

Ironically, Mark Mackey, president of the National Assn. of Variable Annuities in McLean, Va., now thinks the Roth has boosted variable annuity sales rather than competing against them.

Notes Mackey: “The Roth IRA brought widespread attention to retirement savings. To the extent that it focused people on saving for retirement, it helped variable annuities.”

Insurance companies have also been marketing variable annuities as a way for individuals to fund their Roth IRAs and other “qualified” retirement plans--against the best advice of a number of financial planners.

Critics note, for instance, that investments placed in IRAs don’t need to be tax-deferred since the accounts themselves are tax-deferred.

“When you go out in the rain, do you need two umbrellas?” asks Ellen Rinaldi, head of variable annuity sales for the Vanguard Group in Valley Forge, Pa. “Of course not. So why do you need to put a variable annuity in an IRA? You don’t.”

Nonetheless, half of all annuity sales are going to investors who seem to want these “two umbrellas,” thank you very much--and the industry is only too happy to oblige.

“We are promoting to our annuity holders the fit that a variable annuity has to a Roth,” notes Meridee Maynard, vice president for annuity products and marketing at Northwestern Mutual Life. About 46% of the Milwaukee-based insurer’s annuity business is tied to IRAs--and 10% of its IRA business is in Roths.

Even outside of IRAs, many financial planners say investors should steer clear of variable annuities.

For instance, many variable annuities impose so-called surrender charges, which tack on a penalty should investors decide to withdraw money early.

And variable annuities are known for their high fees. According to mutual-fund-tracking service Morningstar Inc., total annual expenses for the average mutual fund are about 1.4% of assets.

Expenses for the average variable annuity, by contrast, are 2.09%, due to additional costs attributed to the life insurance wrapper.

Even before the capital gains tax cut, critics of variable annuities said it could take as many as 12 years for the tax deferral benefit of a variable annuity to make up for the higher fees.

And after the capital gains tax was lowered--lessening the value of tax deferral--that break-even point was, in some cases, extended further. (Industry officials dispute this, noting that high turnover among mutual funds tends to lead to higher capital gains taxes than critics factor into their analyses.)

But NAVA’s Mackey says comparing variable annuity fees against mutual funds expenses is awkward since, along with insurance, annuities offer several payout options upon withdrawal--including guaranteed payments until death--and the choice of investment vehicles.

Variable annuities offer investors a choice of several sub-accounts, which are mutual fund-like investments. The typical variable annuity allows investors to choose among 10 to 20 sub-accounts, which could range from growth stocks to international equities to bonds.

Says Kristine Pancare, vice president of insurance product marketing for the John Hancock Funds in Boston: “Consider a day like [Aug. 4, when the Dow dropped nearly 300 points]. People were besieging mutual fund companies to move their money out of stock funds and into bond or money market funds. Anyone in a variable annuity today can move their money around within their contract without taxes. But fund investors are getting socked with capital gains taxes when they try to do the same thing.”

Notes Jean Sullivan, a consultant with Cerulli Associates in Boston: “While there was a big brouhaha about the capital gains tax, it was so far removed from what [annuity] contract holders were thinking that it had no impact.”

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Still Hot

Sales of variable annuity investment contracts defied expectations to set a record pace so far this year. Annual totals and first-half 1998 sales, in billions of dollars:

First-half 1998: $49.9 billion

Source: Variable Annuity Research & Data Service