Tuesday, July 28, 2009

What Do I Need to Know About Variable Annuities?

Variable annuities enable investors to defer taxes on investment gains until money is withdrawn. Additionally, variable annuities have a death benefit guaranteeing the beneficiary a specified amount – usually the amount invested – upon the investor’s death. For a fee, most annuities offer “living benefits” guaranteeing a rate of return (usually 2 to 5 percent) over time. Withdrawals can be taken as desired, or converted into a fixed periodic payment (annuitized). Withdrawals before age 59½ suffer a 10 percent penalty.

Annuity gains are ordinary income, currently taxed between 10 and 35 percent. While most investments receive a “step-up in basis” that eliminates or drastically reduces the taxes heirs must pay when selling inherited assets, annuities don’t receive a step-up in basis so heirs must pay taxes on the difference between the investment’s cost and current value.

Annuity salespeople are commonly paid an up-front commission ranging from 5 to 10 percent. Although the purchaser doesn’t pay the salesperson directly, the insurer charges the investor high recurring fees to recover this expense. Additionally, separate recurring fees are charged by both the insurer and the underlying funds. After adding the cost of living benefit riders to the contract, fees often exceed 3 percent per year. Comparatively, according to Morningstar the average domestic mutual fund charges 1.35 percent.

Another consequence of high commissions paid to salespeople is the attachment of a surrender charge to annuity policies. Surrender charges discourage investors from withdrawing funds before the insurer recovers the commission paid to the salesperson. This charge usually starts at 7 to 15 percent and declines over 5 to 15 years.

Annuities are appropriate for specific circumstances, such as leaving assets to qualified charities or providing extremely risk-adverse investors with guaranteed income. If you believe an annuity would serve your purpose, it’s time to learn a well-kept secret: you can purchase an annuity without funding a salesperson’s vacation. No-load (no-commission) annuities commonly charge less than half the recurring fees of loaded annuities and have no surrender charge. No salesperson is going to discuss this option. A fee-only financial advisor who isn’t influenced by commission-based compensation can provide an objective opinion on whether an annuity is a wise investment and direct you to a no-load product.


buyapension said...

A variable annuity is a very good option for your manage money, I think that if you don’t know in what investing, the best option for that you earn sure money is this, with variable annuity you’ll have a sure future.

Lon Jefferies, MBA, Independent Financial Planner and Fiduciary said...

The annuity industry employs individuals to write positive comments about their products online. If you couldn't tell by the above user's title, "buyapension" is very likely one of these employees. This individual frequently writes similar comments whenever I mention annuities in my blog posts. I usually delete comments from this user because of his clear agenda, and because they are poorly written. I've decided to leave this comment due to its relevance to the topic and because I believe it supports my opinion that the annuity industry consists of salespeople, not financial advisors that are concerned about their client's best interest.