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Benefits and Tradeoffs
A balanced, non-promotional analysis of what CDAs offer and what they cost.
Potential Benefits
Lifetime income guarantee
A CDA provides a contractual guarantee that income will continue for the investor's lifetime, even if the underlying investment account is depleted to zero. This addresses longevity risk: the risk of outliving one's assets.
Assets remain invested and accessible
Unlike a traditional annuity, a CDA does not require the investor to surrender control of assets to an insurance company. The underlying account remains in the investor's name and continues to participate in market growth.
Potential for account growth
Because the underlying assets remain invested, the account can grow in favorable market conditions. Step-up provisions may allow the benefit base to lock in gains, potentially increasing the guaranteed income amount.
Flexibility compared to traditional annuities
CDAs generally offer more flexibility than traditional variable annuities. Assets are not locked inside an annuity contract, and the investor may have more investment options and greater portability.
No annuitization required
The investor is not required to annuitize (convert assets to an irrevocable income stream). The guarantee activates only if the account depletes, preserving the option to leave assets to heirs if the account is not depleted.
Compatible with fee-based advisory relationships
CDAs can be applied to accounts managed by a registered investment adviser, allowing the advisor to maintain the advisory relationship while adding an income guarantee.
Tradeoffs and Risks
Insurance fees reduce net returns
The CDA insurance charge is an ongoing cost that reduces the net return on the investment account. Combined with investment management fees and advisory fees, total costs can be significant and compound over time.
Investment restrictions may limit growth
CDA contracts typically restrict the underlying investments to an approved list or require volatility-managed strategies. These restrictions may limit diversification and reduce the account's growth potential.
Complexity
CDAs involve a dual-account structure (account value and benefit base), complex contract terms, and multiple fee layers. They are difficult to understand and compare without careful analysis.
Insurer claims-paying risk
The guarantee is only as strong as the insurance company's ability to pay. If the insurer becomes insolvent, the guarantee may be impaired. State guaranty associations may provide limited protection, but coverage for CDAs is uncertain in many states.
Not FDIC or SIPC insured
CDA contracts are insurance products. They are not bank deposits and are not insured by the FDIC. The underlying investment account may be covered by SIPC for brokerage failures, but the insurance guarantee itself is not SIPC-protected.
Surrender charges may apply
Terminating a CDA contract during the surrender charge period may result in a fee. This reduces liquidity and flexibility during the surrender period.
Tax treatment of guarantee payments
When the insurance company begins paying guaranteed income (after the account depletes), those payments are generally treated as ordinary income for tax purposes. The tax treatment of CDA fees and guarantee payments can be complex; consult a tax professional.
Guarantee does not prevent investment losses
A CDA does not protect the account value from market losses. It only guarantees that income will continue if the account reaches zero. Investors may experience significant account value declines before the guarantee activates.
Fiduciary and Suitability Considerations for Advisors
Financial advisors recommending CDAs must evaluate whether the product is in the client's best interest under applicable standards, including the SEC's Regulation Best Interest (Reg BI) for broker-dealers and the fiduciary standard for registered investment advisers.
Key considerations include: total cost relative to alternatives, the client's need for guaranteed income, the client's ability to absorb the ongoing fee, the suitability of the approved investment options, and the financial strength of the issuing insurer.
Advisors should document their suitability analysis and ensure that clients receive and understand all required disclosures, including the contract, fee schedule, and any applicable prospectus or summary document.
This section is educational. Advisors should consult compliance counsel and follow applicable regulations. See also: Advisor Due Diligence Checklist.