Ever had a variable annuity pitched to you? Maybe you own one. They’re a popular way for many people to mix guaranteed retirement income with the growth potential of equities.
But I’m guessing even if you hold a variable annuity, you’re not 100% sure how it works.
“What are the annual fees again?”
“How does that bonus period work?”
These were a few of the questions a client asked me recently when he was considering a variable annuity.
**Full disclosure – I do not sell variable annuities**
This client just wanted a second opinion. He’d recently met with an advisor who pitched him a variable annuity, and wanted input from an objective source.
My client was in a tough position. He’d just lost his father, and was about to receive a sizable inheritance. He wanted to use this inheritance to produce income throughout retirement, since he was about to turn 60.
He was skeptical about investing in the markets, fearing that another financial crisis would destroy his nest egg. At the same time, he struggled with the idea of buying an annuity. He was attached emotionally to the money since it was coming from his father’s estate, and he didn’t want to fork it over to an insurance company. On top of that, the annuity he was considering was complicated and confusing, and he was feeling a little lost.
After walking through everything together, my client decided to use some of his inheritance to purchase an annuity – but not the one he was being pitched. He opted for a fixed rather than a variable annuity, which he bought with a small portion of the money from his father. He decided to invest the majority of the money in a diversified portfolio geared to produce income.
My client isn’t alone, and I get a lot of questions about variable annuities. Since they have so many moving parts, I wanted to share exactly how I analyze variable annuities using my client’s contract as an example.
There’s a lot of nonsense floating around the internet when it comes to annuities. Hopefully this framework is useful to you if you’re considering buying one.
American Legacy Annuity Analysis
In this video, I’ll analyze the American Legacy variable annuity offered by Lincoln Financial Group, which my client was considering. This specific contract is the American Legacy Shareholder’s Advantage annuity, with the i4LIFE Advantage Guaranteed Income Benefit. I’ll also assume that the Enhanced Guaranteed Minimum Death Benefit (EGMDB) is chosen.
Framework: How a Variable Annuity Works
Before we discuss how to analyze a variable annuity, let’s take a step back and review how they work & where they came from.
Variable annuities have become very popular in the retirement planning industry over the last 25 years. Essentially, they’re a contract between you and an insurance company that guarantee you a series of payments at some point in the future.
There are two phases in a variable annuity: the accumulation phase and the payout phase. What’s unique about a variable annuity is that you invest your contributions during accumulation phase – hence the term “variable.” These investments are known as sub accounts and behave a lot like mutual funds. They are professionally managed and will follow a specific investment strategy described in a prospectus.