Life Insurance & Annuities Forum

What are the advantages to purchasing a variable annuity in a 401(k) or 403(b) plan as opposed to mutual funds?

Scott, New Jersey

Dear Scott,

In general, variable annuities (VAs) are viewed as an alternative or supplement to the tax-deferred savings that can accumulate in 401(k) or 403(b) accounts, and even in individual retirement accounts (IRA).

So while an agent may try to persuade you to roll money from your 401(k) or IRA into a variable annuity, you should keep in mind that this money is already tax-deferred. That could mean you would end up paying higher fees for a tax-deferral feature you already have, and losing withdrawal flexibility.

Outside of existing retirement accounts, VAs offer features that can make them more attractive than mutual funds over the long run, but they also carry higher fees and more restrictions. Experts estimate that on average it takes 10 to 15 years of tax-deferral to justify owning a variable annuity instead of a mutual fund.

So if you plan on holding on to your money for a short period of time, such as one to 15 years, and if you think there's a chance you will have to tap into your money before age 59½, the flexibility of a mutual fund may make more sense for you. Also, if you withdraw money from a variable annuity before hitting 59½ you will have to pay a 10 percent tax penalty that you would not face with a mutual fund.

However, the prospect of creating a lifelong income stream is a strong point in favor of variable annuities. So if you want that security and if you are already contributing the maximum to your 401(k) or other tax-deferred savings accounts, a variable annuity might be right for you.

Read The basics of annuities and Five variable annuity salespitches to look out for to find more information on purchasing annuities.

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