A Two-for-one Investment

A Two-for-one Investment

Variable annuities are hot, but are they the right choice for you?

Money has been gushing into variable annuities, which are essentially tax-advantaged mutual funds in a life insurance wrapper. Some $50 billion was poured into variable annuities in 1994, up from just $8 billion in 1991, according to the Georgia-based research firm VARDS Report.

Variable annuities are retirement accounts that allow you to invest in a menu of mutual funds, stocks, bonds, and money markets. Unlike regular annuities, the amount you get when you start withdrawing depends on the performance of the funds you choose.

One big attraction of variable annuities is that earnings within the annuity are tax deferred until you start withdrawing the money. Another lure: If you die before age 59-and-a-half your heirs will get back at least what you put in. Even if the funds you pick do poorly, your heirs won’t suffer. The guarantee doesn’t apply if you live past 59-and-a-half, however.

Annuities come in several varieties. Younger people who are saving for retirement often choose deferred annuities, which allow you to pick a future date for income payments to start. Older folks prefer immediate annuities, often purchased with a lump-sum payments at once or soon after you buy them. Variable annuities give you the option of investing in different mutual funds, so that monthly payments fluctuate with the markets. Fixed annuities are invested in bonds and mortgages with fixes return rates, so you are guaranteed at least a specified minimum payment.

For all that allure, variable annuities have some big drawbacks. For one, most of them have surrender fees – fees that you pay if you decide to withdraw funds before the end of the term – that start as high as 9 percent. As with other retirement accounts, the IRS will hit you with a 10 percent tax penalty on earnings if you withdraw your money before you turn 59-and-a-half.

Statue of Liberty. Photo by Elena

Another downside: hefty ongoing expenses. The average expense ratio of variable annuities is 2.1 percent, but it can run as high as 3 percent, compared with 1,3 percent for the typical diversified stock mutual fund.

The high costs come from running the account, for compensating the broker of financial planner who sells you the annuity, and for providing insurance protection. Expenses are paid directly out of earnings, reducing both yield and total return.

Still, if you’ve exhausted other tax-deferred plans and are in a high-income tax bracket, variable annuities may be for you. Steven B. Weinstein, editor of the Arthur Anderson Personal Financial Planning Newsletter, suggests asking the following questions before investing in variable annuities.

Have you already made the maximum contributions available to other tax advantaged investment plans? Do you plan to hold your investment at least until you reach age 59-and-a-half? If you are in the 28 percent or 31 percent federal tax bracket, do you intend to hold your investment for 10 years or more? If you are in the 36 percent of higher tax bracket, do you expect to hold your investment for at least 15 years for bonds and at least 20 years for stocks? Do you expect to be in a lower tax bracket when you retire and annuity withdrawals begin?

If you can answer “yes” to any of these, variable annuities may fit the bill.

One further bit of advice from financial advisors: Pick solid, aggressive funds with low fees, and then stick with them for the long haul.

Performers in the bunch. Morningstar, Inc. rates variable-rate annuities based on performance and risk in one comprehensive evaluation. Morningstar gives five stars to annuities, or subaccounts, as they are called, with the most attractive risk/reward profile.

The least attractive get one star.

Manulife Lifestyle Emerging Growth Equity, Aetna Marathon Plus Alger Growth, Amer Skandia Advisors Choice/Alger Growth, Amer Skandia AdvisorsDesign/Alger Growth, Guardian Investor/Gardian Real Estate Account, Anchor National ICAP II Foretign Securities, PaineWebber Advantage Annuity Global Growth, Prudential Discovery Plus Real Property Account, Prudential VIP-86 Real Property Account.

All about annuities

Need information about annuities sources or immediate annuity payout rates and data? Try the following:

Reports: Comparative Annuity Reports. First-year rates for fixed annuities.

Life Insurance and Annuity Shopper: Immediate=annuity payout rates and other statistics on fixed and variable deferred-annuities.

Morningstar Variable annuity/Life Performance Report. Performance rankings and various other statistcs for variable annuity subaccounts.

Basic information: National Insurance Consumer Helpline. This hotline is sponsored by the insurance industry trade associations.

Trained personnel and licensed agents will answer questions about insurance sources and send consumer brochures. They also will give advice on other insurance issues.