Variable Annuities are not dead. And they will never die.
Such declarations came in piles by mail, snail and e, from devoted planners in response to a recent column ( 8/17 /97) declaring VAs to be like Randy Newmans’ short people— a product with no reason to live. Variable annuities would continue to be used, the missives declared, for reasons too subtle for a dimwitted newspaper columnist to comprehend.
To which I have a simple response: phooey.
Rather than argue the nuances of sensitively developed insurance products, let us visit my hero, the Couch Potato Investor. This investor, you will recall, approaches life with sublime calm. He has made fogging mirrors his life work. The Couch Potato does not choose between a fund that is aggressive, merely growth oriented, or one that invests in the darkest corners of the known world. Nor does he optimize his asset allocation.
No, the Couch Potato Investor is a dork with broad, positive thoughts. He buys an index that reflects the performance of the largest 500 companies in the US of A and says, “Hey, Is this a Great Country, or what?”
Having heard, once, that taxes are the price of civilization, the Couch Potato pays taxes on dividends and capital gains as required even though it slows down his rate of growth.
“I’m a pay as you go kind of guy”, he says.
He does, however, try to have as little as possible between him and the return on his investment. So he puts $10,000 in the Vanguard Index 500 fund, a no-frills, no-load fund.
His experience?
Take a look at these numbers. If he had invested 15 years ago, his original investment would have grown to a hefty $110,280.
That calculates to an annualized rate of return of 17.35 percent. The cost basis for his investment would be his original $10,000 plus some $23,331 in dividends and capital gains that were reinvested. This means he has an unrealized capital gain of $76,949.
Yes, he would have more money if he hadn’t had to pay any taxes. But the Couch Potato isn’t complaining. With the new capital gains tax rate he will eventually be able to pay only 20 percent in taxes on his accumulated capital gains. He will pay capital gains taxes of $15,390 compared to ordinary income taxes of $23,854.
To see how the Couch Potato Investor did against leading variable annuities, I searched the Morningstar Variable Annuity database for the 25 largest sub-accounts with a history of at least 15 years— the suggested time horizon of a variable annuity investor. Then I rank ordered them by annualized rate of return and inserted the Index fund performance where it belonged.
The result?
The Couch Potato came out 9th of the 25 sub-accounts with the greatest assets, regardless of investment category. It would also have come out 9th on a list of 25 sub-account funds that only invested in equities. In other words, it did better than 61 percent of its variable annuity competitors before the capital gains tax advantage is taken into account.
The Couch Potato Versus Leading Variable Annuity Sub Accounts
| Sub-account Name | Morningstar Category | Annl’d Total Return | Total Exp. | Sub-account Net Assets (in millions) | Policy Name |
| Hartford DCPlus-Q 20th Cent Ultra | Large Growth |
20.52 |
1.85 |
194.88 |
Hartford DCPlus (Q) |
| Prudential VCA-2 Account (Q) | Large Blend |
19.35 |
0.88 |
635.58 |
Prudential VCA-2 Account (Q) |
| MassMutual Panor-Q Growth | Large Value |
18.75 |
1.31 |
249.7 |
MassMutual Panorama (Q) |
| TIAA-CREF Stock | Large Blend |
18.66 |
0.54 |
93114.44 |
TIAA-CREF (Q) |
| Hancock Accom U-SP Growth & Inc | Large Blend |
18.15 |
1.27 |
167.54 |
John Hancock Accom (U) (SP) |
| Hancock Accom U Growth & Income | Large Blend |
18.15 |
1.27 |
255.76 |
John Hancock Accom (U) |
| Equit Equi-Vst-S100-200 Common | Large Blend |
18.08 |
1.75 |
3867.72 |
Equitable Equi-Vest (Series 100, 200) |
| MassMutual Panor-NQ Growth | Large Value |
17.87 |
1.31 |
132.2 |
MassMutual Panorama (NQ) |
| Vanguard Index 500( taxable fund) | Large Blend |
17.35 |
0.20 |
NA |
|
| Aetna D MAP 2 (A)-Q Ae Variable | Large Blend |
17.33 |
1.68 |
216.28 |
Aetna VA Acct D MAP II (Q/Alloc) |
| Allmerica VA-Q/Growth | Large Blend |
16.49 |
1.73 |
222.7 |
Allmerica Variable Annuity (Q) |
| Allmerica VA-NQ/Growth | Large Blend |
16.22 |
1.73 |
253.7 |
Allmerica Variable Annuity (NQ) |
| Lincoln Multi Fund-FP Gr & Inc | Large Blend |
16.16 |
1.36 |
3001.18 |
Lincoln National Multi Fund (FP) |
| Great Amer Rsv Unflx Com Stock | Mid-Cap Blend |
16.15 |
1.8 |
166.62 |
Great Amer Res Uniflex VA (SP) |
| Great Amer Rsv Maxflx Com Stock | Mid-Cap Blend |
16.15 |
1.8 |
166.62 |
Great Amer Res Maxiflex VA (FP) |
| Lincoln Multi Fund-FP Spec Oppr | Mid-Cap Value |
15.44 |
1.44 |
697.06 |
Lincoln National Multi Fund (FP) |
| IDS Flexible Annty Cap Resource | Mid-Cap Blend |
14.83 |
1.68 |
3861.04 |
IDS Flexible Annuity |
| Kemper Advtg III Q Tot Return | Domestic Hybrid |
13.08 |
1.89 |
508.59 |
Kemper Advantage III (Q) |
| Kemper Advtg III NQ Tot Return | Domestic Hybrid |
12.47 |
1.89 |
109.33 |
Kemper Advantage III (NQ) |
| Kemper Advtg III Q High Yield | High Yield Bond |
12.21 |
1.95 |
136.8 |
Kemper Advantage III (Q) |
| IDS Flexible Annty Special Inc | Long-Term Bond |
10.82 |
1.68 |
1687.65 |
IDS Flexible Annuity |
| Lincoln Multi Fund-FP Bond | Intermediate-Term Bond |
9.95 |
1.51 |
264.16 |
Lincoln National Multi Fund (FP) |
| IDS Flexible Annty Moneyshare | Money Market |
5.42 |
1.56 |
227.5 |
IDS Flexible Annuity |
| Guardian VG 2/Guard Cash | Money Market |
5.42 |
1.54 |
106.78 |
Guardian Value Guard II |
| Best of Amer IV/Nwde Mny Mkt | Money Market |
5.22 |
1.81 |
469.43 |
Best of America IV/Nationwide |
| Prudential Medley-Q VCA-10 | Large Blend |
– |
1.75 |
490.71 |
Prudential Medley (Q) |
Source: Morningstar Principia Plus
It should be noted that this is the worst comparison. If you make the Draconian assumption that the investor cashes out at the end of the period, the capital gains tax advantage takes the performance up to 3rd place, the top 12 percent.
A good financial planner would correctly argue, however, that most people don’t spend 15 years deferring taxes just to pay them all in one lump. Instead, we’ll make a long series of income withdrawals and defer paying the tax still further.
When that happens the variable annuity holder pays at ordinary income tax rates, an assumed 31 percent, while the Couch Potato Investor pays at 20 percent. The result? The Couch Potato Investor places 5th for after-tax income. That’s the top 20 percent.
In other words, with no exposure to early withdrawal expense, penalties for withdrawal before age 59 ½, and with no limitations at any time on withdrawals, the Couch Potato Investor will do better than 80 percent of his well guided competitors.
I like those odds.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by PNW Production
(c) A.M. Universal, 1997