How to Create Your Own Variable Annuity


Guaranteed income often comes at a very expensive price. Luckily, there is a way to avoid purchasing a costly variable annuity while still providing a steady stream of income.

Variable annuities can have a place in a portfolio. There are some honest advisors who offer this type of insurance product. Unfortunately, far too many salespeople (posing as financial advisors) misuse variable annuities and give the entire industry a reputation, quite frankly, it deserves. The problem is these annuities are often sold to the masses as some sort of magic bullet. The siren’s call of guaranteed income, no matter how badly the market preforms, is a temptation many investors cannot resist.

Here is the problem in a nutshell. Many of these products can cost between 3-4%, annually. This includes the investment sub-accounts which usually contain very high-priced mutual funds and the various riders to the policy, which will guarantee an income stream.

Due to these costs, the policy many times will pay out a guaranteed income that could be below the average rate of inflation. In other words, the internal rate of return of the policy may not keep up with the cost of living. This makes your “income guarantee” much less valuable than advertised.

Some policies also have features that, if you tap into the principal, the guaranteed income will be negated or severely diminished. So much for that 1% fee you have been paying for this privilege over the last several years.

In addition, there are often very high surrender fees attached to these products. I recently saw one in which the first-year surrender fee was an astonishing 18%. This means if your circumstances change, you will have to pay a hefty price to get your own money back.

What should you do if you want to have a guaranteed stream of income in your retirement beyond social security or any pension you may receive?

Here is a much more cost-effective alternative to accomplish this goal. This strategy does not replicate the intricacies of variable annuities, but the end result could be much more investor- friendly.

If you are at least a decade away from retirement (or, preferably more), this strategy is worth considering. Today, it is very easy to construct a globally diversified portfolio at a fraction of the cost of the annuity. It is not unusual to create some sort of balanced mix of global stocks and bonds for 0.09% or less.

Evidence has shown that buying and contributing regularly to a low-cost, globally diversified portfolio is a smart strategy for investors over long periods of time. Why not create a portfolio with these same types of characteristics to put you on the path to the guaranteed income you desire? Contribute 10-15% of your salary annually and see where this leads you after a decade or more.

Since there has never been a 20-year period where the overall market produced negative returns, you are not taking a reckless gamble with your money.

You can then take this accumulated sum and purchase a low-cost fixed annuity from a reputable provider that is not conflict-ridden. This insurance product is much less convoluted than a variable annuity. In addition, it also provides a variety of choices on how to receive your income.

This strategy may allow you to avoid high fees and accomplish your goal of a stream of guaranteed income.

I already hear the haters out there screaming, “How can you compare this to the guarantees of an insurance company? There are so many holes in this strategy; I cannot even begin to state them. BTW you are also an idiot!”(Edited version)

Here is my response to the so-called guarantees of the insurers. If, over a 20-year period, a portfolio constructed of about 10,000 individual stocks and bonds is devastated, what makes you so sure the large insurer who guaranteed the annuity payments will even be solvent?

That is something to think about.

In the end, it is wise to determine your ultimate goal– guaranteed income, and then work on a strategy that will hopefully leave more money in your pocket than in a salesperson’s wallet. In the words of Warren Buffet’s right-hand man, Charlie Munger, “Think forwards and backwards-invert, always invert.”

This strategy may not be for everyone but it is never a bad idea to look at all the alternatives before making a financial decision.

If nothing else, this investment process is a lot easier to understand than the 500-page prospectus that comes as a complimentary gift when you purchase your variable annuity.