A variable annuity is an insurance contract that facilitates investments in moderate to high-risk mutual funds, often with no base guarantees. It pairs the characteristics of an annuity with those of risky mutual funds. Variable annuities were initially introduced as an alternative to fixed annuities. Instead of declared interest rates and moderate growth, this type of annuity promised rapid fund accumulation through greater participation in the market. Despite the good intentions, variable annuities turned out to be very controversial and maligned. Many of the complaints about variable annuities arise from the sharp, unethical or self-interested practices of annuity sellers.
• Exploitative practices
If variable annuities were easy to understand, it would be harder to dupe unsuspecting annuity investors. However, annuities – while they are simple in concept – can be somewhat intricate for the uninitiated. This allows annuity sellers to exploits those because the commission is larger for these products than with other annuities or financial instruments. Inadequate disclosure, churning and inappropriate sales tend to create problems for annuity investors when they discover the financial lemon they bought.
• Financial risks
Higher participation in the market offers better rates, but this comes at much higher risk. The risk associated with variable annuities is not limited to the nature of the fund either. For instance, variable annuity funds are not FDIC insured and do not offer the same guarantees as a fixed annuity. In addition, there are fund management fees and other hidden fees in such financial instruments.
It might take as much as one or two decades of having a variable annuity for the returns to significantly outweigh the investment charges. Variable annuities may also include added expenses for living benefits and other provisions that the insurer may opt to offer.
What is onerous about these fees is that they might be higher than those of other financial instruments as well. The net value of the accumulated variable annuity fund (not just the rate of return) could also fluctuate according to the vicissitudes of the market.
• Surrender charges
Most annuities bear penalties for withdrawal (about 10%) before age 59 ½, because they are considered Individual Retirement Accounts. In addition to these charges, annuity providers also levy their own surrender charges against the cash value once withdrawals are made before a certain number of years. Surrender charge periods may be as short as six years or last up to 15 years.
• Actual fund performance
In the realm of investment, there is a risk-return trade-off; higher returns mean higher risks. This is acceptable, but with the variable annuity, it sometimes seems as though higher risk equals lower returns. A major complaint about variable annuities is that they do not perform according to expectations – or significantly better than other income options. Variable annuity quotes often use projected rates, and annuity sellers use fantastic projections to lure investors as well. The end result is, invariably, disappointment for variable annuity investors.
• Unnecessary additional benefits
To make variable annuities seem more attractive, insurers may include insurance benefits that annuity investors do not need. Due to the other expenses associated with variable annuities, taking extra benefits on it that may not even be used are not cost effective, especially since these benefits are included in the costs of the annuity. Underwriter solvency, extra feature costs and insurance provider risk charges would also be included as part of the cost of increased market participation.
Generally, variable annuities seem to benefit annuity sellers and providers more than annuity investors. The main concern about variable annuities is their regulation; including the practices of sellers in attempting to get clients to buy into the concept. Although the sales of variable annuities are good, this does not necessarily indicate its value. Perhaps some of these plans are worthwhile, but they should be deemed a last resort for investors.