9 Reasons You Need To Avoid Variable Annuities

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ADVISOR NETWORK | 7/02/2012 @ 12:26PM | 10,548 views

ADVISOR NETWORK | 7/02/2012 @ 12:26PM | 10,548 views

9 Reasons You Need To Avoid

9 Reasons You Need To Avoid

Variable Annuities

Variable Annuities

Eve Kaplan, CFP(R) Practitioner, Contributor

Eve Kaplan, CFP(R) Practitioner, Contributor

Suze Orman

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time or effort.

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when criticized

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To Avoid Variable Annuities

Click for full photo gallery: 9 Reasons You Need

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commissions

forreceive

selling emails

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(note:

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know

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from

annuity

promise

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old father

is a great

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of a potential

variable

commissions

for selling

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(note:

they don¡¯t

know I don¡¯t

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a financial

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sell him

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of a potential

years annuity

ago, when

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showed

proposal

me ¨C the

victim

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financial

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to sell

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9 surrender

Reasons

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- Forbes

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able

to access

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was 10

years

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3% per until

year. My

he turned

89.

father

would not have been able to access this annuity without penalty until



9 Reasons You Need To Avoid Variable Annuities - Forbes

he turned 89.

What are variable annuities? Briefly, they are a mutual fund type of

account overlaid with a thin layer of insurance. If you fund an annuity with

after-tax money, all future gains are tax-deferred (taxed at a higher ordinary

income tax rate than capital gains rates). If you fund an annuity with taxdeferred dollars, you¡¯re not doing much except adding a layer of unnecessary

fees.

A recent ¡°The Great Annuity Rip-Off¡± article on is a concise

summary of the benefits (a handful) and drawbacks (many) of investing in

variable annuities. Here are some key points distilled from and

previous articles I¡¯ve written about variable annuities:

1.

If you truly want to convert after-tax dollars and gains to tax-deferred gains, you

can pour money into a variable annuity but be aware you do NOT receive a tax

deduction since annuities are not qualified retirement products.

2.

It could make sense to annuitize a variable annuity (convert your lump sum to an

income stream) if you end up living a substantially longer life than the statistical

average.

3.

Fees typically are very high ¨C at least 2% per year, including ¡°mortality and

expenses.¡± Some variable annuities cost 3-4% per year.

4.

Investment options typically are limited and often have high underlying expense

ratios.

5.

The insurance component is misleading ¨C it¡¯s not insurance in the common sense

of the word. ¡°Insurance¡± in variable annuities typically guarantees you¡¯ll receive at

least the amount of money you initially invested into the annuity if you die (unless

you have a rider that increases the coverage ¨C but these are rare since the 2008

meltdown). If you die suddenly, you get the value of your account (if you haven¡¯t

yet annuitized) ¨C the ¡°insurance¡± only has value if your investment plunged

dramatically vs. your initial purchase amount.

6.

Annuities are disadvantageous to inherit if they don¡¯t go to a spouse. If the money

formerly was after-tax dollars, the heir receives no step-up in basis on accounts

with gains. If you invest the same dollars (after tax) in a stock fund, your heirs

benefit from a step-up in basis at the date of death or 9 months later. This is hard

to quantify but a step-up in basis is a powerful tool to reduce capital gains taxes.

7.

Disclosure to individuals ¨C at least the clients I work with ¨C is very poor. I

typically see a lot of confusion on the part of clients who bought variable

annuities. These are complex instruments with many moving parts that aren¡¯t

always adequately explained (or even understand) by the seller. Folks who buy

annuities don¡¯t understand the tax ins and outs and often are told variable

annuities are ¡°safe¡± etc.

8.

Variable annuities typically lack liquidity and can tie consumer money down with

prolonged surrender penalty periods.

9.

Variable annuities convert lower capital gains rates on taxable income (if the

annuity is purchased with after-tax dollars) into a higher tax rate levied on

typically see a lot of confusion on the part of clients who bought variable

annuities. These are complex instruments with many moving parts that aren¡¯t

always adequately explained (or even understand) by the seller. Folks who buy

annuities don¡¯t understand the tax ins and outs and often are told variable

annuities are ¡°safe¡± etc.

8.

Variable annuities typically lack liquidity and can tie consumer money down with

prolonged surrender penalty periods.

9.

Variable annuities convert lower capital gains rates on taxable income (if the

annuity is purchased with after-tax dollars) into a higher tax rate levied on

ordinary income. This can cost consumers significant tax dollars down the road.

Forbes cites a study by Richard Toolson (Accounting Professor at

Washington State University) has looked at issue of break-even points for

9 variable

Reasons You

Need To Avoid

Annuities

Forbesfunds in a lower-turnover stock

annuities

vs. Variable

investing

the -same

index mutual fund ¨C assuming both earn the same pretax return. According to

his calculations, an individual in a 36% tax bracket will never come out ahead

by investing in a variable annuity due to the prolonged drag of fees and tax



issues.

There are unusual situations when a variable annuity may make sense ¨C e.g.

doctors who are concerned about malpractice suits. Three-quarters of US

states protect variable annuity assets from creditors ¨C regular IRAs do not

benefit from ERISA protection and may be more vulnerable to creditors.

There are a few other instances when variable annuities may make sense ¨C

but they¡¯re few and far between. More often than not, it¡¯s clear that variable

annuities always benefit the seller, and only infrequently benefit the buyer.

If a new client comes to me with variable annuities, they¡¯re immediately

reviewed by an annuity expert who provides objective feedback. If the

annuities are in an IRA account, it may make sense to dismantle the annuity

altogether. If the annuity is funded with after-tax money (a so-called ¡°nonqualified annuity¡±), it can be rolled into a less expensive annuity via a

¡°Section 1035 Exchange.¡± Otherwise, the annuity can¡¯t be terminated if

funded with after-tax dollars.

The best policy is to steer clear of variable annuities or engage the advice of a

professional who does not sell products and isn¡¯t friends with the potential

annuity seller (conflict of interest). To quote Suze Orman: ¡°I hate variable

annuities with a passion¡­especially variable annuities that are used in

retirement accounts¡­I think variable annuities were created¡­for one reason

only¡­to make the financial advisor selling you those variable annuities

money.¡± Well said!

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