Warning: this is an in-depth review of the Pacific Choice Variable Annuity. Many annuity critics point to complexity as being a major negative for this asset class and Pacific Life doesn't dispel this criticism. The prospectus totals a voluminous 132 pages. So buckle up and let's dig in.
The annuity business has grown in popularity as investors, especially those nearing retirement, look for options to protect themselves from stock market volatility and give them a decent income stream in retirement. With over $200 billion in annual sales, the annuity industry is big business with lots of salesmen trying to persuade you to make a purchase.
You will often hear that annuities are sold, not bought. This is exactly why I will go in depth into some of the most popular annuities because there is shockingly little information available about annuities. Most of the information comes from the companies that sell the annuities and they gloss over the fees, risks and downsides. More importantly, annuities have grown into extremely complex instruments which even the most season professional may have trouble deciphering. My philosophy with any investment is to never invest in anything that you don’t understand and with a prospectus of a lengthy 132 pages, the Pacific Life Pacific Choice Variable Annuity isn't for the average Joe. I don't know anyone that wants to read a prospectus that long.
It is of the utmost importance to make an informed decision. I have dealt with too many clients that have come to me asking for help getting out of an annuity and I can’t help after the fact. Stiff surrender penalties can’t be avoided for many years after you sign on the dotted line.
A Perspective That You Can Trust
I am writing this blog from the perspective as a curious analyst. I am totally impartial as I am a fee only registered investment advisor. I don't get paid to sell annuities nor do I personally sell them. I hope to bring a unique perspective to this topic drawing on my years of experience analyzing companies as a research analyst. I’ve met with hundreds of company CEOs and CFOs and I will use my analytical skills to break down these complex instruments into something easier to understand.
While many investment professionals hate annuities, I do not believe that they are all bad and some of them can make sense as a small part of your investment portfolio. Annuities should never, I repeat never, be the large majority of your portfolio because of their lack of liquidity which is one of their biggest drawbacks.
Issuer Review: Pacific Life
It is important to look at the issuer of the annuity first because annuities are NOT a guaranteed investment of any sort. This is important to note so I will say it one more time. Annuities are NOT guaranteed. They are only backed by the ability of the issuing insurance company’s ability to pay. Therefore if the issuer goes bankrupt, you are at risk of losing everything! On the ninth page of the prospectus, it states clearly:
Pacific Mutual Holding Company is the parent company of Pacific LifeCorp, which is the parent company of Pacific Life Insurance Company. Offering insurance since 1868, Pacific Mutual sells life insurance, annuities, mutual funds, retirement solutions, real estate investments, aircraft leasing and reinsurance services.
Pacific Life receives very good credit ratings from all the major agencies. Fitch rates it A+ (Strong), Moody's rates it A1 (Good) and S&P rates it A+ (Strong).
S&P states that "Pacific Life's competitive position is very strong. The company has been very successful in penetrating the highly competitive affluent marketplace because of its unique and diverse distribution network and positive brand recognition within its target market. We consider Pacific Life's capital and earnings to be strong."On the negative side S&P states:
- The company still has a sizable in-force block of older business, exposing it to volatile equity markets and dropping interest rates.
- Most of Pacific Life's earnings sensitivity is in its Variable Annuity line, where the combination of lower fee-based income, increased liabilities associated with guaranteed living benefits, and increased hedging costs led to a sharp deterioration in performance mid-year 2011...
- Pacific Life's risk position is intermediate, highlighted by the modestly elevated commercial mortgage exposure in its investment portfolio. Pacific Life has a concentration of very large loans, many of which are of types we believe are most vulnerable to elevated losses in a weak economy.
- The most severe risk arises from equity-market exposure from its Variable Annuity business.
Annuity Review: Pacific Life Pacific Choice Variable Annuity
Maximum age for initial purchase: 85
Minimum initial premium: $2,000 (Qualified), $10,000 (Non-qualified)
Pacific Life stated fees: 0.95%-1.35% (mortality and expense risk charge), 0.25% (administration fee), 0.20% (Stepped-Up Death Benefit II Rider Charge), 1.00%-2.75% (optional riders)
Mutual fund expenses: 0.28%-2.73%
True all in fee: 1.48-7.28%
A quick note, the prospectus for this variable annuity is an exhaustive 132 pages. While it was shorter than my last month's read of Transamerica's VA of 480 pages, it was still a doozy. This is not a simple product and has lots of fine print. Unfortunately it was written by lawyers for the benefit from the issuing company, not for the clarity and understanding of the buyer. If you are considering investing thousands or hundreds of thousands of dollars, don’t you think you need to know exactly what you are getting into? Lucky for you, I did the heavy lifting for you and will give the highlights.
The huge knock on variable annuities is the high fees that are associated with annuities and this one is no different. It is no surprise that the fee structure is also complex.
Pacific Life charges a minimum of 1.20% annually (1.6% if you choose no surrender fees) plus 0.2% if you want the stepped-up death benefit rider. Then it has 6 optional riders with the CoreIncome Advantage Select Charge (Joint) running a hefty 2.75%.
In addition, the underlying mutual fund fees add between 0.28%-2.73%. This is in addition to the Pacific Life fee but they likely won’t mention it at all. While the potential fees are listed in the prospectus, it is cumbersome to find the expense ratios for the individual funds listed on the Pacific Life website. I looked at over 25 mutual funds choices for this variable annuity and the typical fees were between 0.9%-1.5%. I didn't find anything close to the listed 0.28% from the prospectus.
Therefore the True annual fees can max out at a staggering 7.28%!!! This number shocked me so much that I had to do the calculation multiple times because I didn't think it was possible. I'd argue that any product that charges that type of fee will never meet your expected return.
Beware of Surrender Fees
Surrender charges aren't as bad as my previously reviewed Prudential or Transamerica variable annuities but they are still bad for the consumer. And if you want to eliminate them altogether, then you have to pay 0.4% more per year in annual fees to Pacific Life. In the 5-Year withdrawal charge option, Pacific Life is locking you into the product for 5 years. In the first 2 years of the contract, the surrender fees run 7%. This drops to 6% in year 3, 5% in year 4 and 3% in year 5.
I believe surrender fees are one of the worst features of annuities. These are huge lockup fees and if you need the money, they sock it to you. This is why annuities should NEVER be a significant part of your investment portfolio because they are essentially illiquid for many years. Unless you are positive you will not need access to these funds, then annuities are NOT for you.
The Pacific Life pitch as per their brochure
Pacific Life Pacific Choice Variable Annuity benefits:
- Grow retirement savings faster through the power of tax deferral
- Protect against inflation and market volatility
- Manage your investment strategy
- Convert your assets through a guaranteed lifetime death benefit
- Leave a financial legacy through a guaranteed death benefit
Most salespeople will likely highlight the value of the additional riders like the CoreIncome Advantage 4 Select (or Guaranteed Withdrawal Benefit XII Rider) which is a Guaranteed Lifetime Withdraw Benefit (GLWB). Remember this is a high fee generating rider for Pacific Life and the salesperson. The GLWB guarantees a lifetime income for the contract owner no matter how long they live or what the market does. Salesmen will focus on how low current interest rates are and will emphasize the ability of this rider to guarantee a higher income. However don’t let any salesman try to overpromise and under deliver. Many agents misrepresent how this annuity and rider will actually perform over the life of the policy. This rider offers 4% annual withdrawal rights for life starting at age 59.5, but doesn't guarantee any compounding. The maximum fees can rise to a maximum of 1.5% for this rider (joint) if the yield on the 10 year Treasury falls below 2%. At current rates, the fee is 1.25%. The 4% annual withdrawal rights don't sound as great when you are paying those fees annually for the life of the contract! At a minimum you have to subtract this out of the withdrawal rights but it is even more if you take into account the accumulation phase.
Furthermore, when you choose this rider, your investment options are limited to investments which are either bond funds or balanced funds. This is done to limit the investment risk to Pacific Life. If your agent pitches you on big investment returns which are on par with the huge equity returns of 2013, then I highly suggest changing agents and at the very least seeking a second or third opinion immediately.
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Who should buy this product?
In summary, this product only makes sense for an extremely conservative investor who is looking for guaranteed income with no market risk. If you are happy with low investment returns and a guaranteed income stream, then this product with a GLWB may be acceptable for you. Be sure to evaluate how it fits into your entire investment strategy and how it will help you reach your financial goals. If you like this annuity, then I’d suggest comparing it to other variable annuities with GLWB to see how the income streams and fees stack up.
In the end, not very many of us should be investing in this annuity. Why? For one, the high fees are eating into your returns. With a true fee of up to 7.28% which is the highest that I've seen to date, it makes most mutual funds actually look inexpensive! This annuity is much like all variable annuities which means high costs and therefore inferior returns. Secondly for those seeking any growth, this annuity isn’t likely to produce much better than single digit returns and I would argue that you may see no growth if you choose only bond funds. Because interest rates are still near historic lows and a portfolio skewed to fixed income assets, the portfolio could actually suffer losses. Please read my previous blog post “Are your bond assets safe in a rising rate environment?” for more information on bond risk.
If you think this annuity is right for you, then definitely read the 132 page prospectus from cover to cover. Because you should never invest in something that you don’t fully understand.
Thanks for sticking with me on this incredibly long blog post. I hope you are able to make a more informed investment decision. Please don’t let your agent pressure you into a sale before you have made an informed decision. Since annuities lock you into a long term contract with stiff surrender fees, please be sure to take your time to make the best possible decision for you and your family.
Have questions about this Annuity?
If you're considering this annuity and have additional questions, feel free to reach out. You can contact us via our secure contact form. We will answer your questions within 24 hours via email. No strings attached, just a little free help to point you in the right direction.
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