Per a client request this week I'll be reviewing the Allianz Alterity Variable Annuity. This will be my first review of a Variable Annuity as the last two that I reviewed were both Index Annuities. There are a few very important differences when reviewing a Variable Annuity versus an Index Annuity. Here's the short and quick differences:
- Variable Annuities are securities products whereas Index Annuities are not. Basically this means that the sellers of Variable Annuities are required to have additional licenses and the regulation of the product is done by FINRA versus each individual state. Variable Annuities are also sold via a Broker/Dealer whereas Index Annuities are sold directly by agents affiliated directly with the insurance company.
- Variable Annuities are not fixed investments - as the name implies. Their value can change each day based on the sub-accounts (which look like mutual funds) and accordingly can lose value.
One thing that's happened though over the past 10 years is Variable Annuities are getting more and more like Fixed Annuities - namely they are offering a myriad of income guarantees to increase their appeal as a retirement vehicle. Most of these guarantees are twofold - 1) they'll have a guaranteed growth rate while income is not used; and/or 2) they will have some type of "lock in" or "step up" that guarantees the value if the sub account investments perform at a rate higher than the guaranteed growth rate.
Like all investment products Variable Annuities have positives and negatives. Further, some annuities are better than others and offer unique features compared to their competition.
This review is of a specific model Variable Annuity one of my clients purchased a few years ago - the Allianz Alterity Variable Annuity. This particular annuity is no longer offered for sale and was replaced a couple years ago with a "newer" model called the Allianz Vision Variable Annuity (effective 6/20/2010).
Some Legal Disclosures
This is a review, not a recommendation to buy or sell a variable annuity. Allianz has not endorsed this review in any way nor do I receive any compensation for this review. This review is meant to be an independent review at the request of a client so they could see my perspective when breaking down the positives and negatives of this particular model annuity. Before purchasing any investment product be sure to do your own due diligence and consult a properly licensed professional should you have specific questions as they relate to your individual circumstances.
The Allianz Alterity Variable Annuity has a few moving parts that are important to break down individually in order to measure their merits. At the conclusion of this review I'll put them all together to get a high level overview of how they work together. The main selling points advisors use when pitching this to potential investors are:
- Invest however you want with dozens of investment options
- Account is guaranteed to grow no less than 7% per year the first 10 years so long as you don't take any income during that time period
- Great for those planning to retire in the next 10 years or just wanting to protect future income
- Tax deferred growth
There's more for sure - but those are the main hot buttons. Essentially the sellers are communicating to prospective clients that you can invest with a long term view because you have no risk in doing so. I'll be breaking down these claims just to see how valid they really are. I'll think you'll be surprised some of the differences between reality and the common sales/marketing practices used in many sales presentations.
The first component is that as an investment with no guarantees. In other words, if you were just using this to grow your capital using the sub-accounts would this product be efficient?
Perhaps this is unfair to look at stand alone - but it is a part of the equation. It's unfair because as a pure "investment" no variable annuity is going to be as good as if the same (or similar) investments were chosen outside of the annuity. This is due to cost alone. Most variable annuities will add greater than 1% in costs just for the basic annuity chassis, not including all the riders and extras that can (and often are) added on.
In the case of the Alterity Annuity the base cost of the contract is 1.35% and the average internal expenses of the sub accounts are over 1% (disclosed in the prospectus as having a range of 0.52% at minimum and 11.52% at maximum). The particular contract I reviewed also had some guaranteed income riders that drove the total cost well over 3% per year.
So if you're buying this or other similar variable annuities for investment performance (regardless of if you are conservative, aggressive, or somewhere in between) you've made a mistake. You'll always be better off removing the insurance costs even if you use the funds that mirror the sub-accounts held within the annuity. In a video below I illustrate this cost and how much it adds up to over time.
Since buying this variable annuity for investment performance alone is not a good idea my guess is that most buyers are doing so because of the other benefits of the annuity. Namely the guaranteed income benefit.
In the Allianz Alterity that I reviewed the owner choose the income rider called the "Prime Plus Benefit." Prime Plus is a guaranteed minimum withdraw benefit (GMWB) that allows the annuity to grow at a guaranteed rate of 7% per year for 10 years regardless of how the investments are performing. It's not all roses though.
When electing this rider account owners are giving up some control over how their money is managed. Basically the insurance company doesn't want to risk the investor being overly aggressive and losing their money so if your account performs poorly they'll step in and change your allocation to something more conservative in effort to mitigate losses.
I've found over the years that most investors don't fully understand what that means or what the repercussions can be. Investors often think this benefit allows them to be aggressive and seek long term growth from their investment knowing there is a backstop against losses - and actually a very nice minimum return - so they needn't worry about how the investments perform.
Nothing could be further from the truth. In reality what will happen if your account goes down too much is your aggressive holdings will be sold and switched into conservative investments. This guarantees that if exercised you will sell low and buy high, automatically, over and over again. Not smart at all.
Hopefully this doesn't happen though. In a perfect world each investor will start with a well balanced portfolio and never need the insurance company to step in to lower their risk. Even in that case though you still pay quite a bit for this 7% guarantee (which really isn't a 7% guarantee - more on that soon).
In the contract I reviewed the cost for the base annuity, this rider, and the administrative charge was 2.2% per year. Add in more than 1% for the sub-account fees and we're looking at a cost of more than 3.2% per year. To put that into perspective if you wanted to 6% net return on your investment you would need a gross return of 9.2%. Since the stock markets long (very long) term average return is only in the 9% range it makes it highly unlikely, probably impossible for any investor to actually earn 6%. I'll illustrate this in the video below.
I wandered a bit - but this section was supposed to be about that income guarantee. The one that promises 7% per year. If that's actually true then who cares what the variable rate of return is? If you can't do worse than 7% its all a moot point, right?
Not so much.
The 7% works like this:
During the first 10 years you own the annuity your "Prime Plus" or guaranteed minimum withdraw benefit grows at 7% per year. This roughly doubles the value of your initial deposit 10 years from the day your start.
But you can't actually take all that money in 10 years. You can only take it out 5% at a time. And once you start taking the money out it no longer grows at 7% per year.
In plain english - what it really does is guarantee that you will get roughly double your money over the course of 30 years so long as you don't take anything for 10 years and no more than 5% of the guaranteed amount in years 11-30.
For those that like to crunch numbers that is an effective rate of return of 3.64% on a 30 year investment. Your real "income guarantee" is no where near 7%. It's really quite paltry and you have to wait 20 years just to break even and 30 years to make even a modest amount. Once that 30 years is up if your "investment" value is gone then you're out of money.
The Video Breakdown
As in most my reviews I feel it's important to show how I did all my calculations. In this video I break down the Allianz Alterity Annuity - it's costs, guarantees, and reasonable expectations for the investors of it.
Some final thoughts
I'm not sold at all on the income guarantee on this annuity. I know they've changed since 2010 (when this one was taken off the shelf) but I'm always curious why when I break these down it's usually a very different process than the process used when they're sold. Like all products/investments there really are pros and cons. This one isn't all bad and does have some advantages over other guaranteed products. It all depends on what kind of guarantees you're looking for and at what cost to access of your real capital.
My guess is most people searching for income guarantees are the ones investing in this annuity. If that's the case you may want to look again.
Since I've reviewed a couple of the hottest selling Index Annuities with Income Guarantees (sometimes referred to as Hybrid Annuities) I thought a little side by side with the Alterity might be beneficial. In order to do this I used the same scenario for all three annuities: A married couple both age 65, $100,000 initial investments, no income for 10 years then maximum guaranteed income thereafter.
Here's how the comparison shakes out:
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As you can see - if an income guarantee is what you're really after a Variable Annuity is probably not the best way to do it. In the examples above the 30 year minimum guaranteed return (assuming you live to 95) is much better with the Security Benefit Secure Income Annuity. The Allianz, however, has the highest maximum return potential of the three. Aviva's BAA12 was right in the middle in terms of both income guarantee and maximum return potential.
So if going the annuity route it's extremely important you know what you want (max safety or max return with no downside) and understand that all of them are long term investments. I think most investors should also consider if given the facts on annuity returns an annuity is best for them at all. For some it might be, for others maybe not.
Thanks for reading/watching this review. It's always fun for me to break down the complicated financial products out there and try to provide some clarity on how they really work. If you have an annuity or other financial product you'd like to see an in-depth review on just let me know, I'd be happy to take a stab at it. If you know someone who has a variable annuity and might benefit from this post feel free to forward it on to them via email. If you have a Facebook account one of the best ways for this message to get spread around is by "sharing" the post by using the Facebook icon below (it's a blue square with a white F on it).