Despite what you’ve heard, annuities aren’t all bad


Since the Department of Labor finalized its fiduciary rule (now in limbo) last year, annuity sales have fallen dramatically as brokerage firms and advisors anticipate that the products may not pass muster under a tighter regulatory standard.

“Companies have been canceling products left and right because they don’t live up to the standard of meeting clients’ best interests,” said Ric Edelman, executive chairman and founder of Edelman Financial Services. Like many advisors, Edelman helps clients undertake tax-free Section 1035 transactions that allow consumers to switch out of high-cost annuity contracts into less costly ones. “With that exception, I never advise clients to purchase annuities,” he said.

Most fee-based financial advisors regulated as fiduciaries appear to feel the same way. David Yeske, managing director of registered investment advisory firm Yeske Buie, said that variable annuities have fallen out of favor with the fee-based advisors he regularly surveys for the Financial Planning Association.

“The use of variable annuities has been declining for years, and that’s probably representative of the fiduciary side of the advisory world,” said Yeske.

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For his part, Yeske is not categorically against fixed or immediate annuities that guarantee income streams for investors, but he has never used them for his own clients. He thinks the adverse tax treatment of variable annuities — the gains in all distributions from the contracts are taxed as ordinary income — makes them a bad idea for savers.

“Variable annuities are a perfect machine for converting capital gains to ordinary income,” he said. While the gains within a variable annuity portfolio are tax-deferred, they are ultimately taxed at up to 39.6 percent, versus the 15 percent capital gains tax rate. “It’s hard to find scenarios where the benefits of tax deferral justify getting taxed at the higher rate.”

Not all fiduciary financial advisors pan annuities, however. Harold Evensky, head of Evensky & Katz and a trailblazer in the RIA industry, believes that low-cost immediate annuities offered by companies such as Vanguard will be crucial for retirees at risk of outliving their assets.

Mark Cortazzo, senior partner of fee-based advisor Macro Consulting Group, thinks there are situations where annuity products are an effective solution for risk-averse consumers. While he has steered very few of his clients toward annuities recently, because of low interest rates and higher prices since the financial crisis, he thinks advisors who ignore all annuity offerings are failing their clients.

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