(PUB) Investing 2016

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12 • Fund Family Shareholder Association
Vanguard’s variable annuities, by
default, carry the Accumulated Value
death benefit, which awards your ben-
eficiaries the value of your annuity
upon your death. If the markets went up
while you were putting money in, your
beneficiaries get the contributions you
made plus the gains you earned. If the
markets declined, however, they may
end up getting less than you contributed
to the annuity. So there is no guarantee
that your beneficiaries will receive, at a
minimum, all the money you put into
your annuity. It’s no different than what
would happen in a regular investment
account. You put money in, and what-
ever happens, happens. Vanguard says
this benefit is “included at no additional
cost,” but there is no way to avoid the
0.195% charge for this death benefit—
it is baked into the expense ratios of
Vanguard’s annuities.
The second option, Return of
Premium, is more expensive, at 0.395%,
but offers protection on the contributions.
Under this option, beneficiaries are enti-
tled to either the annuity’s accumulated
value or the sum of the contributions less
any withdrawals and applicable taxes,
whichever is greater. That sounds great,
but if you invest in an annuity for a long
time (and remember, I said that you
need to be here for decades to offset the
costs), hopefully your account value will
far outpace your contributions. In that
case, you are essentially paying up for
nothing—the accumulated value should
be higher than the value of your contri-
butions alone.
One final gripe with the death benefit:
There’s no step-up in cost basis, so your
heirs will owe taxes on the full amount.
The final piece of the annuity story
is guaranteed income. Vanguard also
offers an optional Guaranteed Lifetime
Withdrawal Benefit (GLWB) rider—
which it now calls “Secure Income”—
on three annuities: Balanced Annuity,
Moderate Allocation Annuity and
ConservativeAllocationAnnuity. The
GLWB is meant to provide a specific
amount of income, set at the time of
the purchase of the rider and dependent
on when you begin taking withdrawals,
regardless of what the market does, for
the lifetime of the annuity.
This is not a free service, however,
and nearly three years ago Vanguard
upped the cost while simultaneously
lowering the maximum annual with-
drawal percentage. (Yet another exam-
ple that proves costs do not only go
down at Vanguard.) If you purchased
the GLWB rider prior to May 1, 2013,
you continue to pay the 0.95% rate, but
if you’ve purchased the rider since then
or plan to someday, the annual charge is
1.20%. And Vanguard has the flexibility
to increase the cost to as much as 2.0%
in the future. As you can see in the table
above, Vanguard reduced the maximum
annual withdrawal percentage, which
determines the amount of income you
receive, by 0.5% for purchases made
after May 1, 2013.
Of course, if you are looking for
guaranteed income, you don’t have to
purchase the GLWB rider. You could
always “annuitize” your assets. This
means you convert your variable annu-
ity to an income annuity by irrevocably
transferring your assets to the insur-
ance company in exchange for regular
income payments. This is one way to
set a floor on your income in retirement,
but keep in mind that you and your
beneficiaries lose access to the principal
and gains (it now belongs to the insur-
ance company, not you), and the guar-
anteed income is only as good as the
insurance company standing behind it.
The final kicker, and possibly my
biggest concern about Vanguard’s
annuities, is that there are only a couple
of great investment options available.
To Vanguard’s credit, a few of the
annuities do offer access to some of the
highest-caliber managers in its stable—
but not many.
Annuities are complicated—there’s
no getting around it. At this point, I’ve
hopefully convinced you that annuities
need further study and that, well, they
are not all they’re cracked up to be.
Though Vanguard barely promotes these
products, assets in the annuity family
hit $23.6 billion at the end of 2015—a
new high-water mark. As the graph
below shows, net new cash flows have
ticked up in recent years, and assets
have more than doubled since the end of
2008. However, this recovery in assets
has been driven almost entirely by the
recovery in the stock market, as net new
cash inflows only account for 16% of the
asset growth over the past seven years.
After years of successfully attracting
assets from investors who owned other
companies’ annuities, most of that money
has been transferred over to the firm’s
lower-cost offerings, putting the annuity
business at Vanguard in a form of stasis.
Even Vanguard’s founder, Jack
Bogle, under whose watch variable
annuities were introduced in 1991, has
less than flattering things to say about
them. “Rates of return earned on vari-
able annuities are certain to be sig-
nificantly lower than the pretax returns
earned through direct ownership of
the underlying mutual funds,” he once
wrote. “Since the higher costs of annui-
ties offset their tax benefits for a decade
or more [and] investing in a variable
annuity program is less flexible than
simply owning a mutual fund outright
and may involve significant tax and
Maximum Withdrawal
Percentages Before
and After
Purchase GLWB
rider before
May 1, 2013
Purchase GLWB
rider on or after
May 1, 2013
Age at First
Withdrawal
Single
Life
Joint
Life
Single
Life
Joint
Life
<59 0.0% 0.0% 0.0% 0.0%
59–64 4.5% 4.0% 4.0% 3.5%
65–69 5.0% 4.5% 5.0% 4.5%
70–79 5.5% 5.0% 5.0% 4.5%
80+ 6.5% 6.0% 6.0% 5.5%
Little NewCash Flows
to Vanguard’s Annuities
Total Assets
Net New Cash
19951997199920012003200520072009201120132015 $-5000
$0
$5000
$10,000
$15,000
$20,000
$25,000
Assets in millions
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