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I’ve disliked variable annuities for
many years because of their high fees and onerous surrender
penalties. Now, low-cost variable annuities are available that slash
fees and do away with the surrender penalties. Does this change my
opinion on the use of variable annuities? Read on to find out.
There is $1.8 trillion dollars invested in annuities and a lot of
that money is in variable annuities. To put this in perspective,
there are $2.1 trillion in 401(k) assets. That’s right. There’s
almost as much money in annuities as there is in 401(k) retirement
programs!
As I’ve mentioned in previous articles on variable annuities
(available at www.guardingyourwealth.com), variable annuities are
sold because of two main features—tax deferral and a death benefit
guarantee.
Tax-deferral is emphasized if you are investing non-retirement
money. Instead of having to pay taxes on dividends, interest and
gains each year, those taxes are deferred until you withdraw the
money from the annuity.
This used to be an attractive option, but not since capital gains
and dividend tax rates have been lowered to a maximum of 15%. You
see, earnings withdrawn from an annuity are taxed at higher ordinary
income rates. These can be as high as 33%.
In years past there wasn’t much difference between ordinary income
tax rates and those on dividends and capital gains. Now, there is a
substantial penalty when earnings are taxed as ordinary income. As a
result, it can take decades before you really see the benefit of
tax-deferral.
The other main selling point of variable annuities is the death
benefit guarantee. Investors like the peace of mind knowing that
even if the market drops substantially, their heirs will get at
least what they initially invested when they pass away. This is used
to entice investors to choose an annuity for their IRA where the
annuity’s tax-deferral feature is worthless.
Unfortunately, investors had to pay through the nose for those
benefits—typically 1.4% of the value of your account each year. On a
$200,000 account, you would be paying $2800 a year. Over ten years
it is likely those benefits would cost over $30,000. That’s some of
the most expensive insurance you will ever buy.
Now there are new, low-cost variable annuities available from
companies like Fidelity and Vanguard that lower the costs of these
benefits. For instance, Fidelity offers one that charges ¼% in fees
each year. That’s 1.15% less each year then the typical variable
annuity. The Fidelity variable annuity still offers the much touted
benefit of tax-deferral but it does not offer the death benefit
guarantee.
If the death benefit is the main reason you want a variable annuity,
you can achieve that goal with the Fidelity variable annuity by
purchasing a separate term life insurance policy. Doing so would
save a 60-year old non-smoking man almost $15,000 over ten years
versus the typical variable annuity.
As investors age, these savings decrease. But even then, you have to
realize that your ‘guarantee’ is actually much higher with a private
life insurance policy than it is with the broker-sold variable
annuity. In the broker-sold variable annuity, your either get the
market value of the contract OR the death benefit, whichever is
higher.
When you buy a low-cost variable annuity and a separate life
insurance policy your heirs receive the market value of the annuity
PLUS the death benefit of the life insurance policy. Even if the
annuity loses half of its value, your heirs still end up with 50%
more than the broker sold annuity. So even if it costs the same it
is still more benefit. And you can keep the insurance policy even if
you cash out your annuity.
The only situation I would recommend a low-cost, no surrender
penalty variable annuity is if you currently have non-retirement
money in a high-cost variable annuity and you have amassed a
significant gain. Even if you have surrender charges, it may be
worthwhile—see how many years it would take to make up the
difference.
For everyone else, I still do not recommend it. If you have IRA
money in an annuity, I suggest a non-annuity IRA when your surrender
penalties end. You can achieve the same benefits for far less cost.
Have a financial question? Send me an email and I’ll personally
respond, free of charge. Go to www.guardingyourwealth.com and click
on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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