The 5% rate is attached to a guaranteed minimum withdrawal benefit. In short, most variable annuities (and equity indexed annuities now) offer a "shadow" account which is used to generate income at some point in the future. The 5% does not apply to account value. How could it, 10 year treasuries, a large portion of insurance company portfolios, are not close to that.
There are a handful of well-priced variable annuities out there that allow people to be invested in the stock and bond markets while knowing there is a minimum return on the income value of the annuity. Most VAs however, are priced at about 3-3.5% all in, which virtually negates any benefit from the income rider. A few years ago the income guarantees were based on 7%, however, with lower interest rates today, there is little benefit available from income riders. Also, since 2008, very few companies actually provide much investment flexibility anymore, instead forcing money into mediocre asset allocation programs. To my knowledge, only Jackson National still gives the investor much fund flexibility.
A VA or EIA is never a good solution for an entire portfolio. The VAs and EIAs with income riders theoretically can work for a small portion of a portfolio that is supposed to generate base income. With interest rates so low though, the same logic applies to annuities as to bonds. Low interest rates, stay shorter duration, i.e. not annuities that lock you in for a very long time. The "lifetime" income riders are a play on fear at this point and an inflation trap as people are getting locked into the lower corresponding rates.
To be clear, because long-term interest rates are so low, using annuities that are supposed to be kept for life is a bad deal as you are locking in the low interest rates and will assuredly lose to inflation over time that way. For most people, an annuity only works for intermediate term income needs. What I will use an annuity for is to provide income for a period of time - never for life - which allows my security investments time to grow. For example, I might use a SPIA with a ten year period certain which allows my stock market investments ten years to sit and grow. Or, I might use an equity index annuity that is deferred from 3 to 5 years and then provides ten years of income. Once again creating a laddering effect so that stock market investments can sit and grow undisturbed.
For most people, using an annuity boils down to comfort with the stock and bond markets. Can they sleep at night with all of their money in the markets? If not, then an annuity has a small bridging role due to the guarantees. Right now, SPIA and EIA are the way to go. VAs are not working due to low interest rates and investment restrictions.
As for the safety question re insurance companies, it is important to know that insurance companies have actually been remarkably safe. Even during the great depression there was never a claim that wasn't paid for financial reasons. AIG paid all of their claims after 2008 collapse. The industry is proportionally self-insured in most states and there is also reinsurance on top of reserve requirements that are far in excess of what banks have to abide. So, the safety question really is a non-issue in most cases for absolute return of dollars. Companies that go under will generally be paid out at contractual minimums however, thus, it is important to know what those contractual minimums are. Stick with "A" rated or better companies and there is rarely a problem. It is far more likely to lose money in the markets than due to the insurance company going bust.
I have not sold a variable annuity in 3 years since the benefits have been watered down due to the low interest rate environment and the investment flexibility being taken away.
Owner Bluemound Asset Management
Owner Wisquote Insurance Services
Last edited by KirkSpano
on Fri Mar 15, 2013 5:25 pm, edited 1 time in total.