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Another Look at Variable Annuities
On my blog, I recently posted "Suze on Variable Annuities" where I quoted her distaste for this product. Admittedly, I added nothing in that post, it was a quote, and little more. I received a number of comments, which asked me to reevaluate the better VAs that are available, and comment. One commenter wrote,"VAs offer guaranteed income through insured systematic withdrawal programs, that allow the owner to take 5 or 6% per year, maybe even more depending on their age, for their entire lifetime and their spouses — guaranteed." Fair enough. I was offered Fidelity's latest Annuity product to review and this article is based on my findings.
First, the product is the Fidelity Growth & Guaranteed Income Annuity. For the single life version, the expense is 1.1%. The underlying fund (Fidelity VIP Balanced is one option) has a reasonable .68% expense. In Fidelity's example, one starts at 65 with $200,000 and has a guaranteed withdrawal of $833. This represents a 5% initial withdrawal which is a floor. i.e. the $833 is the minimum until the next reset. If the Annuity Contract Value is higher at the end of year 1, the monthly withdrawal will rise. To be clear, monthly withdrawals are guaranteed, and can only rachet up, but the Annuity Contract Value is calculated based on the return of the underlying fund and fees.
Since historical data is not available for the underlying fund, I substitute a mix of 60% of the S&P return (including dividends) and 40% of the ten year bond rate for each year.
After creating spreadsheets to help backtest the data, these were my results after year 20 (age 85);
Initial Year MonthlyWithdrawal Contract Value
1980 $1871 $448,969
1990 $1285 $176,153
2000 $833 $154,191*

*Well, I know it's not 2020 yet, but the decade has started so poorly it would take 12 years of 15% returns for the contract value to recover to $200,000 and offer any chance of higher withdrawals. The results are quite varied depending on the market at the time the Annuity is purchased.

The method used in the Fidelity Annuity is interesting to me in one regard. It only takes one bear market to keep the payout capped. Here's why; If a bear market is a 30% loss, you are now taking out 7.14% (this is 5/70) of the contract value in that next year. Add the 1.78% fee, and that's 8.92%. So while that 70% needs to see the market go back up 42% to break even, you are still taking these withdrawals. Can the market recover in 3 or 4 years? Of course it can, just don't count on it.
I must say, I find it curious that the brochure Fidelity offers shows a hypothetical example in which the $833 grows to $1,012 by year 6 (as the Annuity Contract Value grows to $242,878), but by year 10, the Contract value is down to $191,380. They offer a footnote, that unless the Contract Value grows to greater than the $242,878 by 85, there will be no further increases in monthly payout. Let's look at that closely. $1012/mo is an annual 6.34%. Add the expense of 1.78, and we are at 8.12%. The account would also need to grow 26.9% over the next 10 years while taking the 8.12% from the Contract Value. Not likely.

On this page I refrain from any emotionally charged wording (such as the Suze quote from my blog), but I still raise the age old VA questions - What do you gain? / What do you give up? If I am making any assumptions that aren't valid, I am open to corrections.

What is the alternative to the potential VA client that would provide the steady guaranteed income the typical client desires with no downside risk? I plan to spend next month's article discussing my approach to this set of desires.

I'll repeat the offer I made on my blog - if someone wishes to write a post describing (along with a link to a prospectus) a VA whose features satisfy the need for inflation adjusted income, along with downside protection, I'll post it.

Until next month,
Joe