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Rollover Assets to IRA Annuities Surge

As if it wasn't already hard enough for mutual fund companies to attract 401(k) rollovers, investors are increasingly taking this money and putting it in annuities within IRA plans. In fact, these types of rollovers have increased 400% over the last four years.

According to a study by the Spectrem Group of Chicago, some 10 million people rolled over their 401(k) accounts from May 2003 to May 2004, amounting to $362 billion in assets. Some 16%, or $58 billion, of those assets were invested in annuities within IRAs, compared to only 4% during the same period in 2000.

"The growth in annuity rollovers is truly stunning, particularly since annuities typically are perceived as being more expensive than other investment choices such as mutual funds," observed Spectrem Managing Director Catherine S. McBreen. "This suggests," she continued, "the elimination of traditional pension funds has left a void for many investors, individuals who are not comfortable managing their own retirement portfolios to provide both income and growth. They would rather just receive a guaranteed, periodic check, and they are willing to give up some return to do it." These survey results, McBreen explained, support past findings by Spectrem that the No. 1 financial concern of retirees is not to outlive their sources of income. Rollover investors appear to prefer variable over fixed annuities, she noted. "There's a perception that they may get a higher return," she explained.

The National Association for Variable Annuities of Reston, Va., praised the Spectrem survey results as proof of the growing popularity of annuities as a pension substitute. "We are glad to see that there is research being done that substantiates the assumption that individuals, as they retire, will want to have some portion of their assets invested in an annuity," said NAVA spokeswoman Deborah Tucker.

The Spectrem study was released on the heels of a white paper by Financial Research Corp, of Boston that found many variable annuity providers have begun targeting the IRA market as a source of assets, a market FRC estimates will reach $4.8 trillion by 2010. Despite Spectrem's findings, however, FRC doesn't see a mass exodus of rollover money into IRA/VAs due to "the negative implications of VAs, such as putting tax- deferred money into a tax-deferred account," said FRC Analyst Lisa Plotnick.

However, since other products, such as mutual funds and separately managed accounts, are more focused on the accumulation period, insurers and their agents should position VAs as part of an overall investor portfolio that also includes these other products but that is different because it can produce an immediate income stream. "That's why we're saying to the insurance industry: Work in combination, not in competition with other financial products.'"

She noted that for most of the last decade, the VA industry has emphasized the accumulation aspects of their products, which made sense because of where the demographics were. "People weren't thinking of retiring," Plotnick explained. "They were thinking of growing some tax-deferred money. Only in the last three to four years have the companies begun to push the annuitization story, but that's meeting with a lot of resistance."

One reason for resistance is that annuitization is not easy to understand, she said. "There are so many moving parts to the income annuity that you really need a degree to understand it fully," she said. This may be why annuitization rates in the industry are so abysmal. One-half of one-percent of all deferred VA contract holders annuitize, according to FRC.

Spectrem's findings confirm the experience of the nation's largest seller of variable annuities, Hartford Life of Simsbury, Conn. "For quite some time, we have had a significant amount of our sales and assets in qualified plans," said Hartford SVP for Investment Product Sales Bruce Ferris. Detractors of putting a tax-deferred product in a tax-deferred plan fail to recognize the benefits of an annuity, "the most important being the ability to provide a stream of income that one can't outlive," Ferris said.

Annuity contracts can also contain guaranteed withdrawal benefits, which guarantee an investor's principal will remain intact if their annual withdrawal rate doesn't exceed a certain percentage, typically 7%, of that principal. Annuities also offer death benefits, which can be a boon to a contract holder's survivors. Last year, the industry paid out some $2.8 billion in death benefits, Ferris noted. "For families, heirs and beneficiaries of contract holders who passed away, those death benefits mattered greatly to them," he said.

One of the greatest knocks against annuities is their cost to investors. But Ferris noted that products, like the Hartford's Director Variable Annuity, can give an investor professional money management, guaranteed income, principal guarantees and death benefits for as little as 198 basis points, which is the average expense of a B share mutual fund.

Nevertheless, the Spectrem findings leave some financial advisers scratching their heads.