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Cents and Sensibility Guy Steele |
Variable annuities
are investments
with pros and consTo save the money you'll need for that comfortable retirement you've been working toward, your best move is to contribute as much as you can afford to your 401(k) and IRA. But what happens if you hit the contribution limits on these two plans? What other investments are there for you? One possibility is a variable annuity. However, before you purchase one, review the positives and the negatives because they're both present.
Let's look at some of the key benefits of a variable annuity.
>> Variety of investment choices. Your variable annuity is made up of several separate investment sub-accounts. Typically, these sub-accounts have different objectives -- aggressive growth, growth-and-income, income, etc. You can divide your investment dollars among these sub-accounts to create a diversified portfolio.
>> Tax-deferred earnings. You'll pay no taxes on your variable annuity's earnings and income until you start making withdrawals, typically when you're retired. Consequently, your money will grow faster than it would if placed in an investment on which you paid taxes each year.
>> Guaranteed death benefit. As with many of these contracts, if you die before you've started taking withdrawals from your variable annuity, your beneficiary is guaranteed to receive a specified amount; at a minimum, this will be the amount of your purchase payments. Keep in mind, though, that guarantees on annuities are backed by the claims-paying ability of the issuing insurance company.
>> Flexible withdrawal options. You generally have a number of ways in which you can take withdrawals from your annuity. You can set up a stream of income that you -- or you and your spouse -- can't outlive, or you can choose to take the money over a certain number of years.
As you can see, a variable annuity does offer some attractive features for anyone interested in saving money for retirement. But, as is always the case in the investment world, there are (at least) two sides to the variable annuity story. So, consider some of the potential drawbacks.
>> Investment risk. The word "variable" means what it says: The value of your annuity can, and will, go up and down, based on the performance of your underlying investments. If these investments are of high quality, and you hold them for many years, you have a good chance of achieving exceptional growth -- but there's no guarantee that your principal will increase, or even be preserved.
>> Surrender charges. If you need to tap into your variable annuity within a few years of purchasing it (typically, six to eight years), you may well have to pay a surrender charge, which declines gradually over time. However, some annuity contracts allow you to withdraw a small percentage of your account value each year, free of surrender charges. And others, such as A-shares, incur no surrender charges.
>> Early withdrawal penalty. If you withdraw money from your variable annuity before you're 59 1/2, you may have to pay a 10 percent federal tax penalty -- and this penalty may be assessed in addition to any surrender charges.
>> Fees and expenses. When you buy a variable annuity, you'll incur annual "mortality and expense risk charges," typically in the range of 1.25 percent of your account value. This charge compensates the insurer for risks it assumes in issuing your contract. You'll also have to pay administrative fees, and fees and expenses imposed by the individual investment sub-accounts. If you're strictly investing for the long term, and you can handle price fluctuations, then a variable annuity might be a great way to supplement your retirement savings -- but don't make any hasty decisions. By doing your homework now, you can avoid a lot of "wrong answers" later.
See the Columnists section for some past articles.
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com
