Insurance Quotes

Get quick and easy insurance quotes

Currently insured?:
Yes No

Five variable annuity salespitches to look out for

Salespitch #1

Many experts advise that you contribute the maximum to your existing tax-deferred plans before you purchase an annuity.

"One of the great things about VAs is tax-deferral. You do not pay any taxes on the money you accumulate until you begin to receive payments from your contract."

Reality: True, VAs build up money tax-deferred, which can result in increased future savings. However, there are other vehicles—such as 401(k)s, 403(b)s, and IRAs—that also build-up money tax-deferred. These savings plans are normally much less expensive than VAs, which have average costs of 2.45 percent of your investment, according to Morningstar Inc. As a result, many experts advise that you contribute the maximum to your existing tax-deferred plans before you purchase an annuity.

Additionally, a Roth IRA provides tax-free investment returns (assuming IRS holding requirements are met) and may be a viable alternative, says certified financial planner Michael Snowdon, a personal financial planning and insurance professor with the College for Financial Planning in Greenwood Village, Colorado.

An agent may also try to persuade you to roll money from your 401(k) or IRA into a variable annuity. However, keep in mind that this money is already tax-deferred, meaning that you will pay higher fees for a tax-deferral feature that you already have, and, if you choose to annuitize, you lose withdrawal flexibility.

Salespitch #2
"Once you reach a certain age, you can convert your money into a lifetime income stream that you cannot outlive."

Reality: Once you're ready to retire, you can choose between receiving all the assets at once, making withdrawals as you like until the assets are exhausted or converting your contract to a lifetime income stream (annuitizing). The prospect of receiving a lifetime income stream is an attractive one, and it's perhaps the strongest selling point of a VA. However, when you annuitize, you lose flexibility. Most contracts will not allow you to take bigger withdrawals from your contract. For example, if you annuitize and begin receiving $1,200 a month from your contract, and later wish to withdraw $20,000 to buy a new car, most contracts will not allow it.

Cynthia Crosson, a life insurance analyst with Fitch Ratings, says that the devil is in the details when it comes to variable annuities. "Consumers should definitely read the contract terms carefully to determine and understand fees and any withdrawal benefits. They should also be aware that the industry has undergone—and is still undergoing—a major shakeout following the extreme market volatility of 2008 and early 2009.  Insurers saw big increases in capital requirements related to the guarantees they were offering on variable annuities," she says.  In particular, a guaranteed minimum withdrawal benefit (GMWB) was one of the most popular and fastest growing products. It allows you to make a minimum withdrawal – regardless of market performance and without annuitizing. 

 In the fourth quarter of 2008, insurers started moving toward simpler product designs which may limit customer options, says Crosson. That means you should be extra careful when reading and understandingyour contract. The good news is that many of the new products may be easier for consumers to understand.

Salespitch #3
"VAs are better investments for retirement than mutual funds. VAs give you tax-deferral, a guaranteed death benefit, and a lifetime income stream, while mutual funds do not."

Reality: While VAs offer features that can make them more attractive than mutual funds over the long run, they also generally carry higher fees and more restrictions. If you plan to keep your money for a short period of time, such as one to 15 years, andyou may need to tap into your money before age 59½, buying a flexible mutual fund may make more sense.

While the average cost for a VA is 2.45 percent, the average cost for a mutual fund is 1.34 percent, according to Morningstar.

Keep in mind though, that "average" does not encompass all costs, Snowdon says. Some VAs have lower fees than 2.45 percent, and some mutual funds have higher fees than 1.34 percent.

Many VAs also require that you pay a surrender fee to cancel the contract. The surrender period ranges fromfive to seven years, and the rate drops each year you're in the contract. For example, you might pay a 7 percent surrender fee if you surrendered in the first year, 6 percent in the second year, and so on.

 Unlike a variable annuity, you won’t pay a penalty tax if you withdraw money from a mutual fund before age 59 ½ (unless the mutual fund withdrawal is part of a retirement account). Also, mutual fund returns are taxed at a capital gains rate, while variable annuity returns are taxed at your ordinary income tax rate, (just as IRAs, 401(k)s and other tax-qualified plans). The income tax rate can be much higher than the capital gains rate.

Salespitch #4
"Many variable annuities now offer a feature that protects your investments from poor market performance. This feature may either guarantee that your monthly payments or your account balance will never fall below a certain amount. This makes your investment safe."

Reality: These features—known as guaranteed minimum income benefit riders—are designed for investors who want to protect their money from stock market slumps.But watch out for fees. The annual cost of these features can exceed 100 "basis points"—or more than 1 percent of your investment. Overtime, these costs can significantly cut into your investment. They are often unnecessary if you're a long-term investor willing to stomach the volatility of the stock market.

Salespitch #5

"VAs offer tax-free transfers among subaccounts. So if you decide to switch to more conservative or risky investments, you will not pay any tax penalty."

Reality: True, you do not pay a tax penalty if you transfer money among subaccounts. However, many companies charge fees for re-allocating your money to different subaccounts, just as brokers charge transaction fees for exchange traded funds and stocks. Fees vary by company, but you often must pay an administrative fee (usually about $20 to $25) for moving your money into different subaccounts. In some cases, the first 12 transfers are free or the fees may be waived if you have a minimum amount in your investment (check the annuity contract for details).

Annuities provide valuable benefits to people in certain situations, Snowden says. "The key in any investing is to do so wisely--investigate the associated costs and limitations, and make sure that the investment meets your needs."

Ready to get a quote?

Get quick and easy insurance quotes