As more and more baby boomers search for solutions to fund their retirement, the number that are investing in variable annuities is swelling fast. Right now, nearly $2 trillion is already invested in them.
A contract between a consumer and an insurance agency, a variable annuity means that the insurer will agree to make periodic payments to the consumer, similar to a mutual fund run by an insurance company, according to James H. Hunt, an actuary affiliated with the Consumer Federation of America.
With a variable annuity there are no taxes paid on the income or investment gains until a consumer withdraws their money, although they are subject to a number of restrictions and fees that are typically quite high.
What that means for the usual consumer is that, before buying a variable annuity (or accepting a buyout offer) they must take some time to consider their own personal financial goals and objectives, as well as asking (and answering) the questions below.
Question 1: What are the Fees?
Most variable annuities contain fees for mortality, expense risk charges, administrative fees, underlying fund expenses and other fees that are asset-based. They also usually have “surrender charges” that can apply if the holder of the contract sells their contract or withdraws too much money during a specific time after the contract has been purchased. A good financial advisor will be able to tell you the total expense ratio, usually stated in the prospectus. This includes most fees that you will need to pay except the fees for brokerage commissions as well as sales charges.
Question 2: In what account is it best to place a variable annuity?
It’s a commonly accepted belief that a person should never own an annuity in a retirement account like a 401(k) or an IRA simply because there is no additional tax advantage. While there definitely is a clear tax-advantaged for taxable accounts with a variable annuity, there actually may be ways to use a Roth conversion in order to capture some of the tax benefit that a variable annuity offers, even if it is in a retirement account. The best person to ask in order to be sure, of course, is your financial advisor or accountant.
Question 3: Is the Insurance Company that issued the variable annuity Strong?
One very important factor to consider when purchasing variable annuities is the strength of the insurance company. You can easily check their ratings with a third-party company such as A.M. Best, Moody’s, Fitch or S&P. it’s an important consideration to be sure, as the guarantees on your variable annuity are based on the ability of the insurance company to pay their claims.
Question 4: How much value does my existing Variable Annuity hold?
Many older variable annuity contracts have benefits and features that are no longer available. These include fewer investment restrictions as well as more generous payouts and death benefits that are superior as well.
Prior to the 2008 financial crisis, variable annuity programs were designed for higher interest rates, much lower market volatility and with less concern for risk, generally speaking. Today it’s much different, obviously, and when evaluating a variable annuity you need to understand the benefits of the particular annuity you are considering purchasing. In the case of the buyouts, you may also wish to change your contract.
One thing to keep in mind is that, if the advisor giving you advice and information also receives commissions for selling you a new annuity, that person may not always have your best interests in the back of their mind.