Variable Deferred Annuities: One Size Does Not Fit All

The main issue here is trying to decide whether it’s a good deal to buy a variable annuity.
The reality is that while variable annuities may be beneficial to some long-term investors, in many cases, the costs of fees and charges may outweigh the benefits.  The bottom line:  Pay attention to the terms of the contract by watching out for fees and charges.

What are Variable Annuities?
Variable annuities are investment products – a type of contract that you can purchase with a single payment or a series of payments, and that have a range of investment and payment options including monthly lifetime payments.   

Issues to Consider In Purchasing a Variable Deferred Annuity:
Do you need an opportunity to save beyond an IRA and 401(k)?  Like IRAs and 401(k) plans, variable annuities offer the opportunity to invest money that is tax-deferred – you pay no taxes on the income and investment gains from your annuity until you withdraw the money.

So, if you are fortunate enough to have inherited a large sum or if you already have contributed the maximum amount to an IRA and 401(k), a variable annuity offers you another opportunity to save even more without an annual contribution limit.

Know When to Hold Them!
Variable annuities appear to make sense for investors prepared to hold on to them for at least 16-20 years, who are attracted to the security of fixed interest rates, or who want the option to have guaranteed payments through out their lifetimes.

However, when you withdraw your money from an annuity, the earnings on the annuity investment will be taxed as if it is ordinary income – taxed at whatever your tax rate happens to be – anywhere from 15% to 39.6%.  Other investments such as stocks and bonds, are taxed at lower capital gains rates from 10% to 20%.

Look at the Fees:
Each of these fees will lower your investment return:

Surrender Charge
– You will pay a surrender charge if you withdraw your money within a certain period after purchase.  Even if you switch from one annuity to another, a new surrender period begins again.  

Tax Penalty – The IRS will take a 10% early withdrawal tax penalty if funds are withdrawn before age 59 1/2.  
Mortality and Expense Risk Charges – These charges account for the insurance risks the company assumes, typically in the range of 1.25% per year.  

Death Benefit – Should you die before collecting payments, some variable annuities provide some guaranteed amount to a beneficiary even if the stock market has dropped.

Bonus Credits – In an effort to attract investments, some insurance companies are offering contracts with bonus credits – generally ranging from 1% - 5% of your purchase payment.  Once again, these contracts often come with higher surrender charges, longer surrender periods and higher mortality and expense risk charges that significantly erode the value of the bonus.

Other Charges – In addition, administrative fees are deducted to cover administrative expenses.  This may be charged as a flat annual fee.  Also, underlying fund expenses may be imposed depending on the mutual funds within your annuities.  Finally, most special features such as death benefits, guaranteed minimum income benefits, or long-term care insurance will carry additional fees and charges.  

Conclusion:
Anyone considering variable deferred annuities should demand clear and concise figures on all fees and charges.  Most importantly, assess whether the costs outweigh the benefits and request any available prospectus from the sales agent.  The prospectus contains important information on fees and benefits.  Readers may also want to view the SEC’s brochure “Variable Annuities: What You Should Know” at http://www.sec.gov/investor/pubs/varannty.htm, or request a copy by calling 800-SEC-0330

Before You Buy a Variable Annuity . . .

  •      Are you buying to save for a long-term goal, like retirement, and do you expect to take the payments in fixed amounts for the rest of your life?
  •      Do you understand how the money is invested, including the risk and possible rates of return?
  •      Do you understand all of the fees and expenses that the variable annuity charges? (Surrender charge, mortality and expense risk charges, underlying fund expenses)
  •      Can you stay in it at least long enough to avoid paying surrender charges or until age 59 ½ ?
  •      Do the expenses outweigh the benefits of the tax deferral?
  •      If there is a bonus credit, will the bonus outweigh all of the fees and charges?
  •      If you are exchanging one annuity for another, do the benefits outweigh the costs?

Related Resources

« Home

Subscribe to our Newsletter: