Buying Variable Annuities
An annuity is a series of payments. If the amount of the
annuity varies, it is called a variable annuity. Life insurance companies sell
variable annuities, which are tax-deferred investments. If you buy a variable
annuity, you select from a range of mutual fund-like investments called
A subaccount's investment performance determines the future value of a variable
annuity. Subaccounts are often conservative funds that invest in bonds with the
highest credit rating. Some annuities also offer subaccounts that invest in
You should carefully read the prospectus of an annuity and the subaccounts that
you select before investing. The investment objective shown in the prospectus
indicates the kinds of investments that the fund buys.
Surrender charges. A surrender charge is a fee that you pay if you sell an
annuity contract within a certain number of years. Surrender charges can be as
high as 9% of the purchase payment, usually falling by 1 percentage point each
Mortality and expense fees. Mortality and expense (M & E) fees, or risk charges,
are paid yearly to the insurer to adjust for changes in the risk characteristics
of its pool of insurees. M & E fees routinely add up to about 1.25% of an
annuity's contract value.
Administrative fees. A variable annuity's administrative fees are often charged
at a flat yearly rate of $30 to $50 per contract.
It's important to remember that variable annuities are already tax-deferred
investments. As a result, you receive no additional tax savings if you buy them
for other tax-advantaged accounts.
The Securities and Exchange Commission (SEC), which regulates the
variable-annuities industry, advises that you only buy variable annuities after
you contribute the maximum allowable amounts to your IRAs and other
Because variable annuities have high fees and are taxed as ordinary income, it
takes a long time for their returns to match the investment returns of other
tax-advantaged accounts. However, variable annuities may be attractive for
long-term investors in some cases since they offer the following features:
Income security for a spouse or other beneficiary. An annuity is a series of
payments that continues until you die. For an extra fee, you can buy a
joint-and-survivor annuity option benefit. This benefit continues to pay an
annuity to a spouse or other beneficiary if you die first.
Tax-deferred growth. Variable annuities allow you to make nondeductible
contributions that grow tax-deferred until you begin to take withdrawals.
Similar to other tax-advantaged accounts, variable annuities have an
early-withdrawal penalty if you take out money before you reach age 59-1/2.
No contribution limits or required distributions. There are no restrictions on
how much in variable annuities you can buy. Also, variable annuities don't have
required minimum distributions (RMDs.
Death benefits. If you die before you begin to receive an annuity, or before a
certain period, your beneficiary continues to receive the annuity as a death
benefit. The amount and duration of the death benefit are determined by your
total contributions, deducting any annuity payments you may have already
You may wish to keep in mind these additional tips:
Section 1035 exchanges. You can usually make tax-free exchanges using a Section
1035 exchange. However, if you do a 1035 exchange, you will likely inherit a new
surrender-charge schedule, as well as owe any surrender charges on the contract
you are selling.
Insurer's credit rating. Variable annuities are only as financially stable as
the insurance company that sells them. You should check the insurer's credit
ratings. Aim for those annuities sold by insurers with credit ratings of
single-A or higher.
The above information is educational and should not be interpreted as financial
advice. For advice that is specific to your circumstances, you should consult a
financial or tax adviser.