Living benefits: Reducing the risk of variable annuities

Variable annuity sales have accelerated sharply, helped in part by new guarantees aimed at protecting your nest egg.

Longer life spans and a declining role for traditional pension plans have raised concerns that more people could outlive their retirement savings. That has boosted interest in variable annuities, which can provide a stream of income for a set number of years or the rest of your life. But variable annuities are also subject to market risk, related to the performance of their underlying mutual-fund-like investments.

Now, a growing number of annuities contain guarantees to shield against such market risk. Called living benefits, these guarantees offer investors peace of mind about their retirement savings, but at a cost. Living benefits can add between 0.15 percent and 1.10 percent in annual fees to a variable annuity's typical costs, which range from about 0.7 percent to 2 percent of the assets in the annuity. What's more, if you diversify your annuity investments among stocks, bonds and other assets, you can often exceed whatever minimum protections the guarantees promise.

Variable annuity sales, after dipping early this decade, started moving higher in 2003 and then leaped ahead to $157.3 billion in gross sales last year, the latest data available, from $133.1 billion in 2005, according to NAVA Inc., the variable annuity trade association.

Helping to fuel the growth is the popularity of living benefits, insurers say. Roughly two-thirds of variable annuities sold in the first half of 2006, the latest data available, carried a living-benefits rider. That's up from two years earlier, when just over half the contracts sold contained such a rider. Another sign of their popularity: Fidelity Investments, which helped set a trend in the industry in 2005 when it rolled out a low-cost variable annuity stripped of most bells and whistles, plans to begin offering a living-benefits rider.

"Clearly we're seeing that living benefits are really driving variable annuity sales," says Mike DeGeorge, general counsel for NAVA, the variable annuity trade association. "They have become very popular with investors."

Variable annuities have a checkered past, largely because of high fees, complexity and previous troubles with state and federal regulators angered by inappropriate sales to seniors. In recent years, the industry has begun to clean up its act by, in some cases, lowering fees, simplifying the contracts and imposing sales standards on the sales force. Variable annuities have for years outsold the more conservative fixed annuities, which provide returns based on a fixed interest rate.