Variable Annuities: The Lowdown

Insurance salesmen often push variable annuities upon investors, possibly hoping to sell these mutual fund-like instruments in order to reap their hefty commissions. But although some current annuities seem more attractive than those of yesteryear, annuities generally aren't the wonder-investments they're cracked up to be. Here are some reasons why:

  • Variable annuity fees can be steep. They can scarf up more than 2% of your holdings each year, according to Morningstar. That's negative growth. On a $50,000 account, you'd be forking over some $1,000 annually. (These fees seem to be dropping in recent years, though.)

  • Earnings grow tax-deferred in a variable annuity, but when the tax is ultimately paid, it's at your normal rate, which might reach nearly 40%. Compare that with the long-term capital gains rate of just 15%. Even if your tax bracket isn't very high, if you choose to withdraw most of your annuity funds at one time, it will likely kick you into a higher bracket.

  • It often takes at least 15 years before the performance of your variable annuity will match the after-tax returns of investments in a taxable account. You'll be tying up your money for a long time.

  • The "death benefit," which will pay your beneficiaries at least as much as you put in to the annuity, is often a selling point. But it frequently costs more than it's worth. Long-term investments in good stocks are likely to increase, not just maintain, their value.

  • If you don't draw out the money before you die, your beneficiaries will be taxed on it. Mutual funds and individual stocks should cost your heirs a lot less.

  • As with instruments such as IRAs, if you withdraw funds before age 59 1/2, you'll be charged a 10% penalty. Better be sure you won't need that money soon.

  • Variable annuities offer the option of annual payments. But you could achieve annual income effectively in other ways: by selling off small portions of stock holdings each year, for example, or investing in other income-producing securities.

IRAs and 401(k)s are generally more effective for socking away money for retirement. (Learn more about 401(k)s and IRAs.) Consider maxing them out before looking at variable annuities. Take the time to learn more about annuities before plunking any money into one.

Learn more pros and cons about annuities in our Annuities and Retirement areas -- and from an even weightier source: the SEC. We've got a discussion board dedicated to annuities, too -- pop in to see what folks are saying.

Read/Post Comments (0) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 514023, ~/Articles/ArticleHandler.aspx, 10/27/2016 10:59:41 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,184.75 -14.58 -0.08%
S&P 500 2,135.57 -3.86 -0.18%
NASD 5,234.70 -15.57 -0.30%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes