So fervent is today’s born-again belief in stocks that even pure savings vehicles are now cross-dressing as investments. Sales are up more than 36 percent for variable life-insurance policies, which let you keep your cash values in stocks. Sales of variable annuities broke all records in this year’s third quarter, according to the Life Insurance Marketing and Research Association. A few banks, not wanting to be left out, offer CDs with returns linked to a market average. Was Mae West right when she said “Too much of a good thing can be wonderful”? Or has stock-market mania nosed into places it doesn’t belong? Here’s how to evaluate today’s popular stocklinked products:
(the ones open to everyone, not the pension annuities). These can best be described as mutual funds wrapped in a small insurance policy. You can invest any sum that you want in stock, bond or money-market funds. Your earnings will accumulate tax-deferred. If you die, your heirs usually will get at least the money you invested–and more if your investments did well. There’s little risk of market loss as long as you’ll hold for 10 years or more. But you’ll need to consider two other hazards:
First, inflexibility. You don’t date an annuity, you marry it–and divorce is expensive. There’s usually an insurance-company penalty for quitting within five to eight years and a 10 percent IRS penalty on funds withdrawn before you’re 59 1/2.
Second, cost. Every year you pay 1 to 1.4 percent for the insurance, 0.3 to 1 percent for stock-fund management and $25 to $30 policy fee. That puts a drag on growth. Over five years, says Jennifer Strickland of Morningstar, the average annuity growth-and-income fund hasn’t done nearly as well pretax as Vanguard’s 500 index fund (also growth-and-income), which follows the market as a whole. Glenn Daily, a New York life-insurance adviser, figures that a highcost annuity, if cashed in all at once, might take 15 to 25 years to equal a comparable mutual fund, after tax.
The irony is that annuities are especially popular with taxophobes–even though they don’t get all the breaks they think. Withdrawals are taxed at ordinary-income rates, which could reach 40 percent or higher; had you bought plain mutual funds instead, your long-term gains would be federally taxed at a top rate of 28 percent. In the 15 percent bracket, tax deferral doesn’t matter much at all.
Who, then, is a variable annuity for? Older people who will build up their savings for a while, then withdraw the money bit by bit over their lifetimes–putting off the tax as long as possible. During the buildup, you should be heavily in stocks; that’s your best chance of compensating for the annuity’s cost. When you start your withdrawals, however, you might do half stocks, half bonds. Ditto for people who roll their pension payouts into annuities; you diversify your money while making regular withdrawals.
Universal policies offer flexible premiums, Variable universals may carry higher fees than other types of insurance. You have a selection of mutual funds, but to beat the costs you should always focus on stocks for growth. If the market goes up, both your cash and your death benefit can rise, too. If the market falls, your policy heads south. If you suffer a spell of bad investment luck, you’ll be faced with two unpleasant choices: put more cash into the policy or lose it entirely. So you’re putting your family’s welfare at risk. A better choice might be straight variable life insurance not of the universal type. You can’t lose that policy as long as you pay the premiums,
The projected returns on variable universal policies look delicious. But after costs and sales commissions, they aren’t nearly as high as illustrated, says James Hunt, a director of the National Insurance Consumer Organization (NICO). A $100,000 “12 percent” Policy he recently reviewed netted down to just 8.5 percent over 20 years, 4.5 percent over 10 years and a loss over the first 5 years. “I haven’t had a client yet who bought a variable plan after looking at the true rate of return,” Daily says. (To get the rates of return on any cash-value insurance policy you own or are considering, send $40 to NICO at P.O. Box 15492, Alexandria, Va. 22309.)
Who is variable insurance for? Someone in later middle age, who will hold the policy permanently but perhaps wants to hedge against death taxes on an estate that’s increasing in value. Rising stockmarket prices can be used to raise the policy’s face amount.
In most cases, you shouldn’t jump from your current policy to a faddish variable one just to get a better current return, says life-insurance adviser Peter Katt of West Bloomfield, Mich. Because you pay a new sales commission, your policy’s cash value will drop and it could take years to earn that money back. Low interest rates on policies don’t matter as long as inflation stays low, too.
Financial planner Steve Ames of Annapolis, Md., calls them “stocks with training wheels.” Your principal remains insured by the Federal Deposit Insurance Corporation, but the size of your interest payment depends on whether the stock market rises or falls. If stocks rise over the CDs’ term, you might earn more than a regular CD would have paid. If they fall, your savings will earn little or nothing. One-year CDs are the riskiest; no prudent investor trusts stocks to rise over so short a term. Your chances improve greatly with five-year CDs, although you still lose the dividends that stocks pay.
Who should buy stock-linked CDs? They say conservative savers. I say no one. CDs are for money you’re keeping safe. If you want a little flutter, buy a mutual fund on the side.
