Investments are like barnyard animals: they come in different shapes and sizes, and they each have the ability to give you different things. Cows give you milk, chickens lay eggs. But what happens if you want both eggs and milk from one investment?
Then you might be tempted to purchase a variable annuity. These types of annuities are different because they can offer investors a kind of two-for-one deal. Learn what this investment was designed to give you, how much it costs, and what investors end up getting instead.
WHAT IS A VARIABLE ANNUITY?
First things first, let’s define the nature of the beast. A variable annuity is a kind of market investment with insurance features. Picture a cow with feathers, or a chicken with hooves. Or, maybe not. But you get the idea: a variable annuity is a combination of two types of financial products, and as such, it gives investors benefits of each. On the market side: When you purchase a variable annuity, you’ll be allowed to select from a menu of investment choices such as mutual funds, sometimes called “proprietary” investments. Every brokerage firm will offer its own special menu of investment choices, and these come with operating expenses, management fees, and market risk just like any other market investment. The value of your variable annuity is dependent on how these market investments perform. On the insurance side: The variable annuity also provides you with a way to receive a stream of income payments at a later date. This complicates things inside of a variable annuity and adds to the fees.WHAT MAKES A VARIABLE ANNUITY SO DIFFERENT?
When you have investments such as mutual funds, you have an investment that involves market risk. If the investments don’t do well, you can lose money. A variable annuity is the only type of annuity which directly invests in the market. In this way, it is different from other types of annuities. It is also different from mutual funds in three important ways:- Variable annuities can give you regular income payments: these periodic payments can be structured to pay you or your spouse for the rest of your life. To guarantee this income, the insurance side of the investment charges you an M&E fee, or mortality and expense risk fee, that typically averages 1.25 percent.
- Variable annuities offer death benefit features: Unlike mutual funds which offer no guarantees against market loss, most variable annuities offer some kind of protection to your beneficiaries in the event that you die before you start receiving income payments. A typical death benefit, for example, may promise to pay your beneficiaries a specified amount if your account takes a hit and you die before receiving income payments. You’ll pay an ongoing fee for this benefit, even once you start receiving the income.
- Your earnings are tax-deferred: Tax-deferred growth allows you to earn more because your savings benefit from triple compounding. You don’t have to pay taxes on the gains earned during that year; instead, those gains (and the taxes you would have paid) are allowed to grow. Market investments such as mutual funds are taxed at the capital gains tax rates unless they are owned inside of a tax-sheltered investment. For example, mutual funds inside of a 401(k), IRA, or 403(b) plan already benefit from tax-deferred growth. Rolling your 401(b) into a variable annuity, for example, would give you no additional tax advantage.
WHAT SHOULD YOU DO BEFORE YOU INVEST?
Make sure you understand the risks, fees, and benefits associated with owning a variable annuity before you buy. Because these products offer salespeople some of the highest commissions in the industry, both the SEC and the North American Securities Administration have issued investor alerts and warnings. Variable annuities are generally NOT right for anyone with a shorter time horizon, for example, an 80-year old retiree, and you may lose money. It can be especially difficult to figure out what fees you will be charged inside a variable annuity. On the insurance side of things, the insurance company is required to state upfront what fees you’ll have to pay when you purchase the variable annuity. They will list the M&E risk fee, administration fees, and surrender fees. What they do NOT have to mention are the fees charged on the investment side of things. Underlying fund expenses, front-load fees, and sales charges do not have to be disclosed. To find those you have to go digging through the fund prospectus.WHAT IF YOU ALREADY OWN A VARIABLE ANNUITY?
While curling up with your 200-page fund prospectus might not sound like your idea of a good time, professionals like us who have been in the industry actually enjoy helping people like you figure out what’s going on. At Annuity Gator, we do the undercover work so that you don’t have to. We’re happy to have your annuity tested for fees, risk, and underlying expenses to help you figure out if you are getting the best product for your money. Schedule your free appointment today.
