Press Responses
February 22, 2001
Letters to the EditorBarron's
200 Liberty Street
New York, NY 10281
To the Editor: We are writing in response to the recent Barron's article entitled "Free For All" by David Franecki, which took a generally dim view of variable annuities. We are concerned that the article provides an incomplete analysis and could, therefore, potentially mislead your readers about variable annuities an important financial product that is helping millions of retirement-focused Americans prepare for their golden years. Variable Annuities in a Bear Market
The article asserts that variable annuities are essentially "mutual funds for cowards,"and that it "took a bear market to wake [investors] up." In fact, variable annuities offer a number of features that make them particularly attractive during declining and volatile markets. First, most variable annuities offer a wide range of investment portfolios, from aggressively managed stock funds to more conservative investments such as bond funds, balanced funds and money market funds. In addition, most variable annuities offer fixed interest rate accounts. These accounts give investors the option of allocating some or all of their investment to a guaranteed insurance contract that is free from the investment fluctuations of the stock and bond markets. The ability to choose from a diverse group of investment portfolios and fixed accounts makes variable annuities attractive in all market conditions. Investors can use strategies such as dollar cost averaging to establish their investment position during a volatile market and automatic asset rebalancing to maintain their desired asset allocation automatically. And, investors can transfer money from one portfolio to another within the annuity as often as they want without paying any taxes. This flexibility allows them to react to changing market conditions, without worrying about the tax implications. The insurance benefits offered by variable annuities also provide valuable protection in a bear market. Beneficiary protection, in the form of a guaranteed death benefit, gives investors the confidence to stay invested in the stock market where the highest returns have historically been since they know that if they die when the market is down, their family will receive at least the amount invested. Many investors consider the death benefit to be vitally important. No one can predict if they will die when the market is up or down, particularly during periods of market volatility. Clearly, it is unfair and inaccurate to characterize variable annuity owners as "cowards" for seeking this valuable protection for their loved ones. The ability to annuitize is another insurance benefit that may be especially valuable during a bear market since investors have the assurance that, even if their other investments are down, they will receive guaranteed income payments for the rest of their lives. Investors can tailor a payout strategy that meets their preferred level of risk, choosing between fixed income payments, variable income payments, or a combination of the two. Variable annuities offer additional insurance benefits. Principal protection features can be purchased that guarantee a minimum level of annuity payments even if investment performance has been poor. These features can also guarantee that variable annuity payments will never fall below a specified "floor." In short, variable annuities offer a number of features and benefits that allow investors to make investment decisions and tailor retirement strategies that reflect their investment needs and market conditions, regardless of what those market conditions may be. Variable Annuities vs. Mutual Funds
The article asserts that "high fees on variable annuities alone can cancel out the eventual tax benefit, when compared to a low-cost, tax-efficient mutual fund." This is hardly an apples to apples comparison. Why didn't the article compare low cost mutual funds with some of the low cost variable annuities mentioned in the article? A fairer comparison was recently conducted by PricewaterhouseCoopers (PwC) which analyzed the after-tax returns of variable annuities and mutual funds having average or "typical" fees. The study examined a variety of fund types and accumulation periods, and calculated the after-tax return to an investor in a mutual fund and a variable annuity that is invested identically to the mutual fund under various distribution options. Using historical income and expense data, the study found that for the average investor and the average variable annuity and mutual fund, the after-tax payouts funded by variable annuity investments are substantially larger than for mutual fund investments for holding periods as short as 10 years. For example, the study looked at an investor in the 36% income tax bracket during the accumulation phase and the 28% bracket during the distribution phase. After-tax payouts funded by variable annuities, per $1,000 of investment, exceed mutual fund payouts by $57 to $3,071 after a 10-year accumulation period. The attached chart, reprinted from the study, illustrates these findings and supports the study's conclusion that variable annuities "are frequently a more attractive investment relative to mutual funds for long-term savers." A few other points on "low-cost, tax-efficient" mutual funds. First, in order to realize the maximum benefit from these funds, one has to employ a buy and hold strategy. Most investors don't fit this profile. Based on data from the Investment Company Institute, the trade association representing the mutual fund industry, the average holding period of stock and bond mutual fund investments is from 3 to 5 years. Mutual fund investors are subject to taxes on any capital gains realized on the sale, exchange or redemption of their mutual fund shares, and these taxes eat away at their investment gains. This is an important consideration that your readers should be aware of, but is ignored in the article. Second, profits from the variable annuity fees the article complains about are used to compensate financial professionals for the guidance and advice they provide to their clients. Many people need help with their financial planning, and for these people, using a trusted adviser or broker makes sense. Finally, mutual funds-low cost or otherwise-don't offer the valuable insurance benefits provided by variable annuities, such as the death benefit and the right to receive a lifetime stream of income. Capital Gains
The article also criticizes variable annuities because their gains are taxed as ordinary income rather than as capital gains. But as the PricewaterhouseCoopers study shows, this is more than outweighed by the fact that variable annuities are tax deferred. In addition, a recent survey by the Gallop organization showed that many annuity owners are in a lower tax bracket when they retire and begin taking withdrawals. More fundamentally, not all gains on mutual funds are taxed at capital gains rates. Mutual funds generally must distribute all dividends, short-term gains and long-term capital gains realized by the fund through its investment activities. Mutual funds investors are taxed annually on their share of distributed income. A mutual fund investor includes all dividends and short-term capital gains distributions in ordinary income. Across all mutual funds, the Pricewaterhouse study found that over 40% of the total return was taxable at ordinary income rates. Finally, paying taxes-even at the capital gains rate-is not a blessing. Many investors in mutual funds are currently dealing with taxes they must pay on "phantom" gains that occurred last year when funds began selling their holdings. These taxes were incurred even though the value of the investors' mutual fund holdings actually declined. This double whammy hit cannot happen with variable annuities because they are tax deferred. * * * * * No product or investment is perfect for everyone, and investors need to fully understand their alternatives so that they can make choices based on their individual needs and circumstances. We share a common goal of educating the public about variable annuities and trust our response will assist you in this effort. Sincerely,
Mark J. Mackey
President and CEO
NAVA
PricewaterhouseCoopers LLP
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