Variable annuities and mutual funds have long invested in similar holdings. Both own port-folios of stocks and bonds, rewarding investors with whatever returns the holdings deliver. But there are important differences between the two types of investments. The average annuity charges annual fees of 2.33%, about a percentage point more than mutual funds, according to Morningstar. The extra costs represent insurance fees, which cover a variety of situations.
If the owner of an annuity dies, heirs may be guaranteed to get back the original principal. Mutual fund owners have no such protection. In addition, earnings on annuities are tax-sheltered until the owner takes withdrawals. Perhaps the most appealing feature of an annuity is the ability of the investor to select a guaranteed income stream for life.
Now the distinction between annuities and funds is blurring. A group of innovative annuities charge annual fees that are lower than those charged by most mutual funds, and several mutual funds offer investors solid guarantees.
One of the cheapest of the new annuities is Jefferson National Life’s product, which charges a flat insurance fee of $20 a month—regardless of how much is in the account. The savings can be particularly notable for high-net worth families. An investor who puts $1 million into the Jefferson annuity need pay only $240 a year to get the right to select lifetime income. “People have avoided choosing variable annuities because they seemed to be expensive and confusing,” says Laurence Greenberg, CEO of Jefferson National Life. “By lowering the costs, we are hoping that variable annuities will play a much bigger role in portfolios in the future.”
Another low-cost choice is Ameritas Direct, which charges annual insurance expenses of only 0.55%. Under the Ameritas program, investors can elect to have their accounts run by top mutual-fund portfolio managers from companies such as PIMCO, Fidelity, and Vanguard.
While annuities are cutting costs, mutual funds are offering guarantees. To satisfy the need for security, Prudential Retirement introduced Capital Guarantee funds. These come with what is known as high watermark protection. Say an investor puts $100,000 into a fund. The assets appreciate to $150,000 and then drop to $80,000. The investor is guaranteed to receive the highest value—$150,000—if he waits until the fund’s maturity date, which can be seven or 10 years after the original purchase. “The idea is to encourage investors to stick with a fund for the long term and not sell when the market turns down,” according to George Palms, senior vice president of investment products for Prudential Retirement.
Will the line between annuities and mutual funds continue blurring? Probably. At the moment, many investors are clamoring for vehicles that come with low costs and security. The financial industry will continue experimenting, trying to deliver what customers want.