I. What Is A Variable Annuity?
A variable annuity is a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date. You purchase a variable annuity contract by making either a single payment or a series of payments. Variable annuities are considered both insurance products and securities products.
Variable annuity products offer a range of investment options. The value of your investment as a variable annuity owner will vary depending on the performance of the investment options you or your broker select. The investment options for variable annuities are typically mutual funds that invest in stocks, bonds, money market instruments, or a combination of the three.
II. How Do Variable Annuities Work?
A variable annuity has two phases: an accumulation phase and a payout phase. During the accumulation phase, you make purchase payments, which you can allocate to a number of investment options. For example, you could designate 60% of your purchase payments to a bond fund, 20% to a stock fund, and 20% to a money market fund. The money you have allocated to each mutual fund option (often referred to as subaccounts)
will increase or decrease over time, depending on the fund's performance. During the accumulation phase, if you decide to withdraw money, you may have to pay "surrender charges" and you may also have to pay a 10% federal tax penalty if you withdraw money before the age of 591/2.
At the beginning of the payout phase, you may receive your purchase payments plus investment income and gains (if any) as a lump-sum payment, or you may choose to receive them as a stream of payments at regular intervals.
Some annuity contracts are structured as immediate annuities, which means that there is no accumulation phase and you will start receiving annuity payments as soon as you purchase the annuity.
Ill. Why Are Variable Annuities Bad Investments for Senior Citizens or Retirees?
Variable annuities may be bad investments for a number of reasons:
A. Surrender Charges - The terms of many variable annuity contracts provide that you must pay surrender charges if you withdraw your
money within a certain period of time (usually 6 to 8 years). This charge may be as high as 8% of the value of your investment.
B. Mortality and Expense Risk Charges - Many variable annuity contracts provide for charges that compensate the insurance company for the
insurance risk it assumes under the contract. This charge is equal to a certain percentage of your account value, usually in the range of
1.25% per year.
C. Administrative Fees - The insurance company may also deduct charges to cover record-keeping and other administrative expenses. This may be charged as a flat account maintenance fee (perhaps 525 or $30 per year) or as a percentage of your account value (usually in the range of 0.15% per year).
D. Underlying Fund Expenses - You will also indirectly pay the fees and expenses imposed by the mutual fund subaccounts that make up the underlying investment options for your variable annuities.
E. Fees and Charges for Additional Features - Some insurance companies offer special features for their variable annuity products. These often include additional death benefits, guaranteed minimum income benefits, and long-term care insurance. All of these often carry additional charges and fees.
F. Variable Annuities in lRAs - Brokers often place variable annuities into a client's retirement account or IRA. This is inappropriate because, while the variable annuity provides you with tax-deferred growth, the IRA already does the same thing. As such, you end up paying for an expensive product that provides no additional tax advantage.
G. Provides No Tax-Deduction Benefit - Money invested in a variable annuity is not tax-deductible as in an IRA.
H. Hidden Fees - Generally, the fees and charges associated with your account are deducted from any increase or decrease in the value of your account prior to statement publication. For this reason, the fees will not be clearly listed on your monthly or quarterly statements.
IV. Why Do Broken and Investment Advisors Sell Variable Annuities?
Brokers that sell variable annuities often get paid very large commissions from the insurance companies that offer the annuities. These commissions (often referred to as "loads") may be paid as soon as you purchase the annuity ("up front load") or may be paid throughout the time you hold the annuity ("trailing loads or commissions").
The amount the broker receives depends on the insurance company. However, these commissions are often a percentage of the total amount invested. While these commissions are paid by the insurance company, the commission gives the broker a reason to place you in a variable annuity rather than in other, more suitable investments that do not pay the broker high commissions.
V. Conclusion
Variable annuity products are rarely appropriate investments for elderly or retired individuals. Variable annuities within an IRA or retirement plan are particularly unsuitable because no additional tax benefit is gained for the investor. Many brokers use these investment vehicles to create wealth for themselves while providing little or no benefit to their customer.
