Beware - Variable Annuities Guaranteed Income Benefits

A man I admire recently wrote a newspaper column which touted a "new benefit" in variable annuities. At first read, it seemed to say that I could get 5% guaranteed income for life, even more if mutual funds I chose in the product did better than 5% and my principal was guaranteed after the surrender penalties or at death. If this were true, I was ready to close down my fee-only business and sell annuities. After my first skeptical e-mail, he agreed to write a follouwp column to clarify the first one. He said to look more carefully at what he had written, that the principal was not guaranteed!!

I wrote a thank you note to this columnist. Here is what I wrote.

Hello from Atlanta from one of your biggest fans in the financial planning business. Thank you for your follow-up article on the "principal guaranteed" variable annuities. Let me share with you how your original column first registered with me and how I fear many people (and yes, salespeople pushing these things) will see the words "principal guaranteed."
As you pointed out in the follow-up column, the attraction of these is that I can start the withdrawals at any time, take up to 5% a year, have that sum guaranteed for my life no matter what, and here is the most important part, the MARKET VALUE of my annuity minus withdrawals and contract charges is left for my heirs ASSUMING my withdrawals have not exceeded the original principal.
I know this now, several weeks after your original column, but let me tell you how I interpreted your first column and I like to think I have fairly trained eyes. Here is what I told my colleagues: "I just read this column from one of my favorite financial writers. He is recommending a new annuity that offers the right to withdraw 5% and a guarantee of principal." You can imagine the stunned looks and skepticism of my colleagues. Here I was, telling them that a person could take 5% out for life no matter what happened to their underlying account and after surrender penalties, they could get all their money back or at death, the original amount they put in would go to heirs! $100,000 in, $100,000 out and no matter what happened to the markets, even a 50% decline like we saw 2000 to 2003 or a market crash like '87 or '89, the original principal was guaranteed after surrender or to the heirs.

Lucky for me, my colleagues all scoffed and said - prove it. As I have sought vainly to find such a product, you then followed up in your July 4 column that the principal was not guaranteed. As you so accurately pointed out in your follow-up column, some money may be left, which is better than the regular annuity where no money is left and income cannot be shut off once it is started. However, my initial impression (and I have to wonder how many readers got the same impression) that I could have all that income and my heirs would then get all my principal at death turns out to be incorrect.
That may have seen obvious to you and in fact, a second more careful reading of your first column shows you actually did not say guaranteed principal, but guaranteed access to principal, which is slightly different. Yet, it is easy for someone to read those two phrases and interpret them as one and the same. What you really pointed out is that these annuities have guaranteed access to principal not withdrawn, but principal is withdrawn in market downturns. The original principal is not guaranteed on surrender or death.

Once again, these products are so complex and the language is so misleading that I predict it won't be long until I hear people insisting (as I originally told my colleagues) that they can buy an investment with guaranteed income of 5% and still have their principal guaranteed. To them, that means $100,000 in, $5,000 a year and after the surrender period or at death, a guaranteed $100,000 back. It means the funds they are in promise only upside and never any downside. I will tell them it is not true and they will look at the product which has the title "Guarantee Principal" and conclude that I am talking through my hat. After all, the agent at the free steak dinner told them it was true and the sales literature says "Guarantee Principal". Anyway, I already have enough of this confusion with the policies out there touting 7% minimums for life, a claim that is also false. (These policies tout a guaranteed "accumulated" value of at least 7% but in fine print say that value is used to determine your future annuitization, which can be done as low as 1% for income payouts! Now, I have to contend with these GMIB 5% "guarantees". The battle never ends. And frankly, while I remain a huge fan, I really wish you had not publicly told anyone you danced with the devil here.