In the US, variable annuities are tax-deferred savings plans. There is no tax on investment gains but tax is payable on the income payments. They have two stages: the accumulation period and the payout period when investors can take income by way of an immediate annuity, (for life or for a specific period), as a single lump-sum amount or through systematic withdrawals.
At retirement most investors choose between taking a lump sum payment (which is heavily taxed), or taking systematic withdrawals which is similar to our drawdown.
Lifetime annuities (like those in the UK) are available but have not been
Many US investors and advisers are now concerned about the risk of systematic withdrawals, particular
with the recent volatility in the global stock markets and are therefore looking
for more income and capital security. Variable Annuities with their combination
of income and capital guarantees have therefore become popular.
In the US it is common for Variable Annuities to include a “Guaranteed Lifetime Withdrawal Benefit” option. The guaranteed lifetime income is payable regardless of investment returns and most contracts lock in investments gains annually. Therefore investors can benefit from a guaranteed income for life without actually buying an annuity.
In addition, if the fund increases in value, the level of income will increase, but if the fund value falls the income will be remain at the level at the last lock in. On death, the funds can be paid as a lump sum to beneficiaries.
The guarantee is provided by the insurance company through a process known as dynamic hedging and the underlying derivatives required to back these guarantees are rocket-science material. The cost of providing these guarantees is normally
paid by way of an additional fund management charge.
The Variable Annuity concept first arrived in the UK in 2007 when the Hartford
launched their VA product. In the UK we find the term Variable Annuity confusing
because an annuity is associated with a guaranteed income for life whereas the VA
is actually an option within a pension plan. Several different names have
been used including, "Unit Linked Guarantees" and "Guaranteed Drawdown".
We prefer to use the term "Guaranteed Drawdown and there are currently three
products in the UK:
Investors in the UK are seeing the income from conventional annuities falling as
factors such as increased life expectancy, low yields and underwritten annuities
force rates downwards. At the same time many so called “Middle Britain”
looking for ways to increase their retirement income whilst still have having
Many are saying that they do not like annuities because if they die
early they will lose the capital, but they are also concerned about the risks
associated with drawdown.
In short, many investors want the best of both worlds; secure income as well as flexibility and investment control. That is exactly what guaranteed drawdown aims to provide.
There is a price to pay to for the lifetime income guarantee and this is represented by an increased fund management charge. Charges differ from company to company but typically range from 0.75% per annum to 1.5% per annum. The costs are lower for other guarantees such as capital only.
Most of the criticism is leveled at the charges. The extra annual management charges eats away at investment returns and in a bull market a naked fund will perform better than a protected fund. But in a falling market the guarantees come into play and the extra cost of the guarantee would have been a price worth paying.
Despite the obvious advantages, some commentators say that while investors may be getting peace of mind they may also be buying something they don't really need at an extra cost. But this is the case with all types of insurance. Supporters of these new products point out that we are happy to pay the cost of house insurance against the small risk that out house burns down, so investors should seriously consider paying an insurance premium against the very real risk that the value of a drawdown funs will fall.
Guaranteed drawdown gives investors the best of both worlds; guaranteed income and flexibility, including the option to change the level of income, control of investments and choice of death benefits including a lump sum (less a 55% tax charge). But this comes with a cost and so investors and their advisers will have to carefully weigh up the advantages and disadvantages.
This website is run by William Burrows, is for information only and does not provide specific financial advice.