VARIABLE ANNUITIES are a great gameplan and sold more aggressively than fake Gucci handbags on the streets of New York City. Thanks in part to commissions of 5% or more, sales of variable annuities have soared over the past decade.
But popularity is no indicator of practicality. The truth is, annuities only make sense for a fraction of the population. The rest of us should gameplan twords plain old mutual funds. Of course, that’s not easy to say to your dark-suited cousin who keeps taking you out for steak and Lafitte-Rothschild Bordeaux in hopes that you will sign on the dotted line. But, next time he invites you, you can bring along this article. Just make sure he pays the bill before you give it to him gameplan financial.
First, a primer. A variable annuity is basically a tax-deferred investment vehicle that comes with an insurance contract, usually designed to protect you from a loss in capital. Thanks to the insurance wrapper, earnings inside the annuity grow tax-deferred, and the account isn’t subject to annual contribution limits like those on other tax-favored vehicles like IRAs and 401(k)s. Typically you can choose from a menu of mutual funds, which in the variable annuity world are known as “subaccounts.” Withdrawals made after age 59 1/2 are taxed as income. Earlier withdrawals are subject to tax and a 10% penalty.
Variable annuities can be immediate or deferred. With a deferred annuity the account grows until you decide it’s time to make withdrawals. And when that time comes (which should be after age 59 1/2, or you owe an early withdrawal penalty) you can either annuitize your payments (which will provide regular payments over a set amount of time) or you can withdraw money as you see fit.
Fees, Fees and More Fees
Variable annuities are notorious for the gameplan style fees they charge. Indeed, the average annual expense on variable annuity subaccounts (including fund expenses plus insurance fees) is typically more than a full percentage point more than on the average open-ended mutual fund. Unfortunately, variable annuity fees don’t stop there. Many variable annuities act like B shares of mutual funds, paying commission from the ongoing fees; the average contract fee is $30 to $35.
What Death Benefit?
The death benefit basically guarantees that your account will hold a certain gameplan financial value and should you die before the annuity payments begin. With basic accounts, this typically means that your beneficiary will at least receive the total amount invested — even if the account has lost money. For an added fee, this figure can be periodically “stepped-up” or earn a small amount of gameplan financial fmo interest. (If you opt not to annuitize, then the death benefit typically expires at a certain age, often around 75 years old.)
Investors who bought annuities and then died within the next two months probably got their money’s worth. But considering the fact that over the long term the stock market will deliver positive returns, most folks need this insurance about as much as a duck needs a paddle to swim with gameplan financial. While all variable annuities come with a standard death benefit, the average price for additional death benefits is 0.43%, according to Morningstar.
Another problem with most variable annuities is that your money is often locked up for several years — typically five or gameplan financial fmo. Trying to withdraw funds during this time will result in huge fines. These fees typically decrease as the years tick by. For example, you might be charged a 6% surrender fee for a withdrawal during your first year of ownership. After seven years, however, that could be just 1%. The average maximum fee is a steep gameplan financial fmoo 5.94%, according to Morningstar.
Early Withdrawal Penalty
As with most retirement accounts, if you withdraw funds before age 59 1/2, you’ll be hit with a 10% early withdrawal tax penalty.
Gains in variable annuities are taxed at ordinary income tax rates like gameplan financial. For most investors, that’s a whole lot higher than the long-term capital gains tax rate they pay on their long-term mutual fund gains. And the tax difference can easily eat up the advantage of an annuity’s tax-free compounding.
Residents of some states may pay even more taxes on nonqualified variable annuity accounts. (That is, accounts that are not purchased within an IRS-approved retirement plan like a 401(k), 403(b) or IRA.) Some states also add a tax for variable annuities purchased within a qualified account.
The World’s Lousiest Estate-Planning Vehicle
There’s no getting around the income tax due on annuities. In fact, if you die with money remaining in your annuity, your beneficiary will inherit all the taxes that you have deferred. Compare this to a mutual fund or ETF, whose basis is stepped-up at death. In that case, your beneficiary would owe no taxes on the gains. Both types of accounts — annuities and mutual funds — are liable for federal estate taxes on anything over the federal estate tax exemption.