Planning for your retirement can be a complicated procedure. There are many financial vehicles available such as your 401K, IRA, fixed or variable annuities. Your broker is recommending a variable annuity. You have questions.
What is a variable annuity?
A variable annuity is a tax-deferred retirement vehicle that allows you to choose from a selection of investments, and then pays you a level of income in retirement that is determined by the performance of the investments. A fixed annuity, on the other hand, provides a guaranteed payout.
Variable annuities were introduced in the 1950s. Investors can invest in a dozen or more professionally managed subaccounts consisting of stocks, bonds or money market funds. This gives an investor the opportunity to earn higher rates of return, which can increase the amount of capital you can accumulate and provide a variable income stream to potentially outpace inflation. However, you also assume the risk that your accounts won’t perform the guaranteed return of a fixed annuity resulting in less capital accumulation and a lower income stream.
Advantages of a Variable Annuity
• Death Benefit—A variable annuity death benefit ensures that the beneficiaries you select will receive the greater of 1) all the money in the account or 2) some guaranteed minimum such as all the payments minus your withdrawals.
• Rate of Return—Some variable annuities offer, for an added charge, to guarantee a minimum level of annuity payments, even if you don’t have enough money in your account due to investment losses to support that level of payment.
• Long-term Care Insurance—Some offer a rider (for a fee) that includes long-term care insurance, which pays for home health care or nursing home if you are seriously ill.
Disadvantages of Variable Annuities.
Variable annuities have a number of risks that could erode their advantages.
First there is the investment risk. If your investments decline, your annuity value declines meaning a lower payout to you. Second, taxes. Like fixed annuities, you’ll pay income tax on the variable annuity’s payments when you withdraw them, plus the 10% penalty if you’re under 59½. Also, any long-term capital gains you build up in stock and bond subaccounts are taxed at ordinary income rates when you withdraw them. Third, fees. There can be surrender fees if you take an early withdrawal, some can have high commission fees, ongoing management fees and insurance fees. Adding up the fees can reveal a large cut in your returns.
When might you use a variable annuity?
• If you’ve maxed out your IRA and 401K investments then a variable can improve your savings for retirement, although you might consider other investments also.
• If you decide to buy a variable annuity, find one with low annual fees and don’t sign up for expensive options.
• Remember, variable annuities are for long-term investments to meet retirement or other long-range goals.
Before you decide to buy a variable annuity, read the prospectus carefully to be sure you understand all its features, the fee and expense structure and whether some benefits such as long-term care insurance can be purchased more cheaply elsewhere.
If you have questions about variable annuities or about your broker’s management of your account, please contact me at: 313-962-7777 for a case evaluation. We are located in Detroit and service clients throughout Michigan and beyond!