Life Insurance & Annuities Forum

Aug. 2, 2007

I have read a lot about the high cost of variable annuities (VAs), but when I compared some B share mutual funds to the same investment categories in a VA, the total costs of the VA were actually less than the total costs of the mutual funds.

If the VA fees are not higher and you get many other benefits, such as a guaranteed death benefit, ability to switch between fund families inside the VA without sales charges, and some tax advantages, why not buy VAs?

Roy, Utah

While VAs offer features that can make them more attractive than mutual funds over the long run, they often carry higher fees and more restrictions than mutual funds. 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.

According to Morningstar, the average fee for a VA is 2.12 percent, while the average fee for a mutual fund is 1.37 percent. This is not to say that you will pay more in fees in every VA as opposed to any mutual fund, but in general, the fees are higher. Due to these fees, says Patrick Reinkemeyer, director of investment consulting at Morningstar, on average it takes 10 to 15 years of tax-deferral to justify owning a variable annuity instead of a mutual fund.

Many VAs also require that you pay a surrender fee to get out of the contract. The surrender period is usually seven to eight years, and the surrender fee generally drops each year you're in the contract. For example, you might pay an 8 percent surrender fee if you surrendered in the first year, 7 percent in the second year, and so on. You don't face those kinds of fees in a mutual fund.

Also, unlike a variable annuity, you do not pay a penalty tax if you withdraw money from a mutual fund before age 59½ (for more on life insurance and taxes, check out Insure.com's Life Insurance & Annuity Tax Tool).

In addition, mutual fund returns are taxed at a capital gains rate, while variable annuity returns are taxed at your ordinary income tax rate, which can be much higher.

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Disclaimer: We are journalists, not financial planners or insurance brokers. Nothing we say should be interpreted as a recommendation to buy or sell any insurance product, or to provide other financial or legal advice.