Retirees Should Avoid Variable Annuity for a Fixed Annuity and More
Beginning retirees who are worried about outliving their income may consider buying a deferred annuity to begin payouts in their 80s as a guarantee to not run out of income. Despite having some 20 years to grow their investment, they should avoid a variable annuity in favor of a combination fixed annuity and a long term taxable investment. Here's why...
Variable annuities (VAs) allow you to invest your premium in a variety of market accounts - stocks, bonds, mutual-type funds. The problem is that although choosing an equity-based investment seems ideal under long investment periods, variable annuities present a costly alternative to other approaches. This stems from variable annuities being essentially mutual funds wrapped in an insurance package.
*Key selling points for VAs are that:
1. they offer a death benefit - insurance that your heirs will receive the greater of your initial investment or the account's current value.
2. your contributions grow tax-deferred - but then you pay income tax on any investment gains when you begin payouts.
*But VA expenses can undermine both these benefits. According to Morningstar:
1. The average VA sub-account expense ratio (including insurance policy exenses) is roughly 2%
2. Most VA's carry surrender charges for early access to you money (typically within at least 5 years) that can approach 10% of the value of your account.
3. Many VA's carry annual policy contract charges of another 0% - 0.79% per year.
4. And VAs may offer some of the highest sales commissions around - accounting for the hard push to sell them
But paying up to 3% or 4% per year in expenses takes a big chunk out of any yearly investment gains undermining that long term growth!
*But what about the tax benefit?
The tax-deferred growth of your VA investment gains comes at the expense being taxed at ordinary income tax rates during annuity payouts - not the lower capital gains rates.
And if you die before annuitization begins, your beneficiary will pay still have to pay that tax.
*A Fixed Annuity coupled with conservative market investments is a better alternative:
Divide what you would've invested in a VA between a deferred fixed annuity and a long term equity investment. The annuity is important since only an insurance product can assure that lifetime income. Invest the rest in long term equity targeting growth through long term capital gains.
The advantage of such an alternative is threefold:
1. The taxable investment portion leaves you the opportunity to access your money without penalty
2. You incur little or no annual tax until you sell your investment - and then you're taxed at only the long term capital gains rate of 15% which gives you effectively tax-deferral and low eventual taxation, and lastly
3. If you die your investment portion will get stepped-up basis resulting in no taxation if your beneficiary sells your investments at your death.
Variable annuities (VAs) allow you to invest your premium in a variety of market accounts - stocks, bonds, mutual-type funds. The problem is that although choosing an equity-based investment seems ideal under long investment periods, variable annuities present a costly alternative to other approaches. This stems from variable annuities being essentially mutual funds wrapped in an insurance package.
*Key selling points for VAs are that:
1. they offer a death benefit - insurance that your heirs will receive the greater of your initial investment or the account's current value.
2. your contributions grow tax-deferred - but then you pay income tax on any investment gains when you begin payouts.
*But VA expenses can undermine both these benefits. According to Morningstar:
1. The average VA sub-account expense ratio (including insurance policy exenses) is roughly 2%
2. Most VA's carry surrender charges for early access to you money (typically within at least 5 years) that can approach 10% of the value of your account.
3. Many VA's carry annual policy contract charges of another 0% - 0.79% per year.
4. And VAs may offer some of the highest sales commissions around - accounting for the hard push to sell them
But paying up to 3% or 4% per year in expenses takes a big chunk out of any yearly investment gains undermining that long term growth!
*But what about the tax benefit?
The tax-deferred growth of your VA investment gains comes at the expense being taxed at ordinary income tax rates during annuity payouts - not the lower capital gains rates.
And if you die before annuitization begins, your beneficiary will pay still have to pay that tax.
*A Fixed Annuity coupled with conservative market investments is a better alternative:
Divide what you would've invested in a VA between a deferred fixed annuity and a long term equity investment. The annuity is important since only an insurance product can assure that lifetime income. Invest the rest in long term equity targeting growth through long term capital gains.
The advantage of such an alternative is threefold:
1. The taxable investment portion leaves you the opportunity to access your money without penalty
2. You incur little or no annual tax until you sell your investment - and then you're taxed at only the long term capital gains rate of 15% which gives you effectively tax-deferral and low eventual taxation, and lastly
3. If you die your investment portion will get stepped-up basis resulting in no taxation if your beneficiary sells your investments at your death.
