Fee-based advisers are warming up to VAs

Slowly but surely, fee-based and fee-only advisers are beginning to warm up to variable annuities.

While I-share VAs, which are designed for the fee-based-adviser set, made up only $2.9 billion of the $117.3 billion in total VA sales through the first three quarters of 2011, that sum reflects a 22.2% jump from 2010.

Jefferson National Life Insurance Co., a prominent seller of flat-fee variable annuities for fee-only registered investment advisers, sold a record $280 million in VAs last year. That’s up by about $100 million from 2010.

Aiming at some of that growth potential, TD Ameritrade Inc. said it will soon make low-cost VAs from Transamerica Life Insurance Co. and Great-West Life & Annuity Insurance Co. available to RIAs through its platform.

A conversion of secular trends is driving that interest: Carriers believe breakaway brokers leaving the wirehouse life and opting to go fee-only are leading the growth in those VAs, especially as they bring along their clients.

In other cases, dually registered advisers who work mostly on the RIA side are searching for products that work with their business model. That adviser audience aims to provide clients with access to living benefits without the inconvenience of surrender charges or commissions.

TAX STRATEGY

But fee-based and fee-only advisers alike said they’re using these products in a manner that’s different from the way their commission-based colleagues do — as a part of a tax-deferred investment strategy or in conjunction with other investments on which they charge fees based on the amount of assets.

“I meet clients who turn up with some enormous variable annuity they didn’t need, and they were told comforting things like “guaranteed income for life,’” said Eve L. Kaplan, a fee-only adviser at Kaplan Financial Advisors. “What the client doesn’t really know is that it’s $200 of income for life.”

Most fee-only financial advisers come across variable annuities when they inherit a client who has one with terms that are less than advantageous to the investor. For instance, the fees might be too high, coming in at upward of 3% for both the traditional VA and a living benefit.

Enter the fee-only variable annuity as a repair job for clients, who are otherwise stuck with the wrong product.

“What fee-only advisers do historically is to move the contracts to get people out of high-priced policies, so it’s purely cost reduction,” said Patty Reiners, assistant vice president of Ameritas Advisor Services. It’s only been in the past few years that advisers in that business model have begun looking at living benefits, she added.

For Ms. Kaplan, fee-only variable annuities have been a way to take care of fixer-upper clients who bought costly products on the basis of sometimes improper recommendations. Primarily working with Jefferson National and Monumental Life Insurance Co., she aims for products with 0.75% to 1% in mortality and expense fees. The typical B-share variable annuity, in comparison, could have about 1.3% in M&E fees.

Further, cheap, nonaggressive investments are the way to go as far as the underlying funds in the VA, said Ms. Kaplan, who favors products from The Vanguard Group Inc.

However, VAs also could be an engine for the tax-deferred growth of exotic investments. That tactic is a favorite of fee-only adviser Steve Blumenthal, founder of Capital Management Group Inc.

His firm provides a variety of tactical high-yield, long/short and equity strategies built within VAs to take advantage of tax-deferred growth.

Using the 350 funds available in Jefferson National’s VA product, Mr. Blumenthal might place 40% of a client’s assets into alternative investments inside of the annuity, while splitting the remaining 60% between stocks and bonds outside of the VA. Available alternative funds include the Credit Suisse Commodity Return Strategy Portfolio or the Avant Gold Bullion Strategy Fund.

“We don’t just invest in real estate investment trusts and gold, but other strategies that can make money when other parts of the portfolio are stressed,” Mr. Blumenthal said. “You can make money in an up market, too.”

But there’s also a tax-planning angle. Inefficient short-term trading strategies done outside of the VA could result in the client’s paying short-term capital gains, but taxes on the gains are deferred within the annuity. This allows the client to compound growth, instead of losing some of those returns to the IRS.

“There’s a tremendous advantage to reserving that tax for sometime in the future, hopefully when you need to live off the income,” Mr. Blumenthal said.

Financial advisers who are dually registered are finding that they’re turning to these annuities if a large chunk of their business is done on the RIA side of their firm.

The products’ profile got a boost last year when LPL Financial LLC bulked up its selection of fee-based VAs, adding on annuities from Allianz Life Insurance Co. of North America, The Lincoln National Life Insurance Co. and Axa Equitable Life Insurance Co., among others.

Commonwealth Financial Network also opened up its platform last year to bring on additional fee-based products.

Lyman H. Jackson, president of Jackson Financial Advisors and a registered representative with Royal Alliance Associates Inc., admits that variable annuities aren’t a large part of his business, which largely operates on the RIA side.

But the fact that he can offer a fee-based variable annuity means he sells clients the products they need in the manner to which they’re most accustomed.

“I’m able to clear the air with the client immediately,” he said. “I tell them this one isn’t sold with a commission and that I don’t earn anything more if they buy it or they don’t,” said Mr. Jackson, who started looking into fee-based variable annuities “with earnest” last year.

In this context, the recommendation has much to do with the living- benefit riders that clients can purchase to get income for life.

However, Mr. Lyman likes the flexibility of the fee-based model most.

“These aren’t for every fee-based account or retiree, and whether it’s fee- or commission-based, it’s long- term,” he said. “But the top advantage is that if it doesn’t work out, you can get out without a surrender.”

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