Jane M. Young, CFP, EA
What is a Variable Annuity?
A variable annuity is a contract with an insurance company where you invest money into your choice of a variety of sub-accounts, similar to mutual funds. Non-qualified, variable annuities provide tax deferral on gains until the funds are withdrawn. Upon distribution your gains are taxed at regular income tax rates as opposed to capital gains rates. Variable annuities generally charge fees twice those charged by mutual funds. Additionally, you will be to subject to substantial early withdrawal charges if you purchase an annuity from an advisor who is compensated through commissions. Most variable annuities provide the option to buy a guaranteed death benefit option and/or a Guaranteed Minimum Withdrawal Benefit. These do not come without a cost and can be very complex. Below are some advantages and disadvantages of Variable Annuities.
Advantages and Disadvantages of Variable Annuities:
- Tax Deferral of gains, beneficial if you have maximized limits on other retirement vehicles such as 401ks and IRAs.
- No Required Minimum Distribution at 70 and ½ as with traditional retirement accounts. There is no Required Minimum Distribution on Roth IRAs.
- Death benefit and Guaranteed Lifetime Withdrawal Benefits (GLWB) riders can be purchased for additional fees. However, the death benefit is rarely instituted due to long term growth in the stock market. GLWBs can be very complex and not without risk.
- Trades can be made within annuity without tax consequences – this is also true within all retirement accounts.
- Non-taxable transfers can be made between companies using a 1035 exchange.
- No annual contribution limit. Traditional retirement plans have annual contribution limits.
- Gains taxed at regular income tax rates as opposed to capital gains rates on taxable mutual funds.
- Higher expense structure –Mortality and Expense fees substantially higher than mutual funds.
- Substantial surrender charges for up to 10 years on commission products
- 10% penalty on withdrawals prior to 59 ½, this is also true with most traditional retirement accounts.
- Complex insurance product
- Lack of liquidity due to surrender charges and tax on gains
- No step-up in basis, taxable mutual funds and stocks have a step-up in basis upon death
- Loss of tax harvesting opportunities