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A variable annuity is an investment product, which is tax-deferred and allows for the allocation of money into mutual funds held in professionally managed “subaccounts”. Variable annuities do not guarantee a return on the principal. In this article, 4 financial experts discuss whether or not variable annuities are a good investment for retirement.
Consumers Should Be Very Careful When Considering A Variable Annuity
“While commonly used and ostensibly for retirement, consumers should be very careful when considering variable annuities, which are a form of life insurance with securities investment aspects.
While some very cheap, the quality product has emerged, the policies consumers are apt to be presented tend to pay high commissions, and be saddled with high costs. These costs range from mortality and administrative (the life insurance part) to the sub-accounts (basically mutual funds) to available riders (more insurance features).
In practice, I have seen these fees as high as 6% annually when loaded up with riders, all of which are commissionable to the sales agent, who of course has a non-fiduciary incentive to push all the bells and whistles.
Often, these costs are invisible to consumers, who may be inundated with pages of disclosure but gain little real appreciation of total costs. If they ask if they pay a commission, agents typically answer that that do not, which is technically true since the consumer gives the money to the insurance company, and the company pays the commission. Of course, the money comes from the investor's principle – it can come from nowhere else – who is saddled with high surrender charges if they try to move the money; these surrender charges the first year are often roughly equivalent to the sales agent's commission.
While annuities can do something nothing else can do – guarantee (so long as the life insurance company makes good on its promise) lifetime income – obtaining this feature from expensive variable annuities may be a mistake.
Finally, for non-qualified accounts (non-401k/IRA) accounts, taxes on annuities can be far, far higher than other alternatives.”
Dr. Jeff Camarda, CFA(r), E.A., MSFS(r), Chairman/Chief Investment Officer, Camarda Wealth Advisory Group
High Fees For Guaranteed Checks, Step-Up Period
“High fees for guaranteed checks – You can buy riders that guarantee lifetime withdrawals or income, principal back guarantee, or additional death benefits. Typical time frames are five to seven years for surrender charges. They are expensive payments. You'll pay a mortality and expense fee of maybe 1.25%, an admin fee around 0.20%, then your rider fee can be another 1% to 1.5%. The sub-accounts your money is invested in is approximately 0.5% to 1.0%. All factors considered you pay high fees to receive the guaranteed checks.
Step-up Period-Most annuities have a Step-up period. For example, Nationwide has 7% simple interest. If you start with $100,000, then next year on the anniversary the income bucket will be $107,000. You typically pull out 4% to 6% of that income bucket based on age. Once you surpass the age of 65 is when you'll receive the largest payouts.”
Chane Steiner, CEO, Crediful
The Higher Fees Negates Them As A Recommended Investment Inside A Tax-Advantaged Investment Program
“Variable annuities do have their place in retirement for those who have taken full advantage of IRA's, 401K's, 403b's etc that provide tax benefits but can be invested in mutual funds – but the higher fees that one pays, at least for me, negates them as a recommended investment INSIDE a tax-advantaged investment program.
In general, the fees on a variable annuity are 1-2% on average higher than those on a mutual fund. If one's investment time horizon is 10 plus years for the money to be working, the return of principal guarantee on the annuity GENERALLY loses some of its value because the risk of losing on comparable mutual funds is much lower.
The big push on annuities for retirement seems to be based on that being one of the only investments that can provide guaranteed lifetime income. But if that is what someone wants, they can also use lower-cost investments during the accumulation period, and then roll those assets into an annuity at retirement (I would not recommend it, but that is an option).
Outside a retirement plan, a variable annuity can be an excellent way to build additional wealth, but from my perspective, whether it is a better idea depends on the tax rate of the investor. At a low tax rate, an investor may benefit from 0% capital gains rate, versus ordinary income rates for funds withdrawn from an annuity.”
Ilene Davis, CFP(R), MBA, Financial Independence Services, Author, Wealthy by Choice: Choosing your way to a wealthier future
Research All Options And Discuss It With Your Wealth Advisors To Weigh Up The Pros And Cons Of Each Alternative
“Any convoluted financial arrangement requires one to exercise an extra degree of due-diligence. Everyone's retirement needs are different, and the terms and conditions in Variable Annuities (VAs) are anything but straightforward. VAs display many pluses. They offer tax-deferred retirement income, especially if you have already maxed out your contributions to other tax-deferred accounts such as an IRA or 401(k).
Generally, the VA investment diversifies traditionally by favoring a mix of stocks and bonds. The difference is this – the insurance company guarantees you can't lose your capital if you stay the minimum surrender term (generally around ten years). So, if you are not withdrawing income from your VA, it's allowed to grow without tax accrual until the day you take it out. On the surface, you have peace of mind (i.e., you can't lose your capital) and no tax headaches while it grows.
There's yet another benefit – VAs offer a death benefit to your dependents. Should you pass away before you've started receiving payments, your elected beneficiary will receive a bonanza from the insurance company. Contributions are flexible across monthly and annual plans to meet your needs head-on. Options in VA policies include periodic payouts over your life even in the face of under-performance. Longevity naturally aligns well with ongoing cash flow from VAs. So where's the catch? VAs carry high fees for administration, special features, life coverage, and mutual fund expenses – as high as 1.25% of your account value, charged annually. On top of that, you may be into withdrawing income sooner than you think, thus nullifying the tax deferral benefits. Finally, if you surrender inside the ten years, you can be heavily penalized. In a nutshell, you may be paying a high price for unnecessary inflexibility and unused features.
So is it good or bad? Without knowing the investor's specific needs, it's hard to say. The scenario's even more confusing when index annuities, fixed annuities, and vanilla funds (the latter with low entry costs and no pack drill) enter the picture. Each has a different angle, offering more of one feature but less of another. It leads us back to the big inevitable retirement planning starting point, better known as Square One. We like to think we can avoid that forbidding place, but it's unavoidable.
Research all options and discuss it with your wealth advisors to weigh up the pros and cons of each alternative. Diversification presents many different avenues. VAs undoubtedly qualify for consideration, but for what percentage of your portfolio, if any? There’s conceivably a lot better out there if your needs don't align in the right way. Conversely, proper alignment of retirement considerations could make VAs the best thing since sliced bread. Take your time, see where you stand, and act accordingly.”
Gordon Polovin, Finance Expert, Serves on the Advisory Board for Wealthy Living Today
There is much debate as to whether or not variable annuities are recommended as a good investment for retirement. If you are interested in potentially investing in this type of annuity contract, factor in what these industry experts have discussed, do your due diligence, and consult with a wealth advisor.