3 things you may not know about variable annuities

More than a few wealth management clients have asked questions about variable annuities, so I thought it would be good to post some information about them.


1. Today’s variable annuities are not your father’s annuities. Older types of annuities gave you a guaranteed income in exchange for a lump sum of money. You literally bought the income but lost control of the money. Today’s variable annuities are different in that you chose how to invest your money, just as you would using mutual funds. You can select options that allow you to take a stream of income that is guaranteed regardless of how the investments perform without turning your money over to the insurance company.

2. Annuities provide the opportunity to guarantee regular distributions of income. This is something no other investment product that I am aware can do. Annuities act like a lifeline, providing steady resources to care for one’s needs. To illustrate:

  • Suppose that you invested $100,000 in mutual funds. Further suppose that the market value of those stocks is now worth only $50,000, due to market volatility. (See “Why are the investment markets so volatile?“) Finally, suppose that you need to draw $5,000 of annual income from this investment.
  • Your mutual fund investments will not likely deliver the income you need. A withdrawal rate that represents 10% of the current balance of the account is, in my opinion, not sustainable.
  • Instead, what if you had invested the same amount in an annuity? The balance in that account might be only $50,000 — same as the mutual funds. But, having invested in an annuity, your $5,000 of annual income is guaranteed. So regardless of the market value, you have the peace of mind of knowing that you can continue your income.

How do they do that? The simple answer is that you pay for annuity income to be guaranteed. Annuity fees can cost more than the fees needed to acquire other kinds of investments such as mutual funds. But, the annuity helps to lock in a stream of income. And for many investors and many investment programs, this is worth the price.

Of course, my discussion is simplified for illustrative purposes. In real life, buying and selling investment products, including annuities, should always been done in conjunction with a plan that fits your wealth management needs and goals and should include help from a qualified advisor.

3. You can understand what you’re buying and the price you’re paying when you purchase an annuity. Some people say that the cost of buying an annuity is next to impossible to understand. While it’s true that annuities are complex financial products, a qualified advisor can help you understand their role, determine whether they fit into your wealth management plan and properly price them. When I write annuity contracts for my clients, the fees are clearly disclosed — down to a 10th of a percent!

It seems fashionable at the moment to discredit annuities because they carry “surrender values.” And, yes, the surrender value for liquidating an annuity can exceed the amount of the original investment. But this should not be surprising. Annuities guarantee income, albeit for a price.

Another factor to consider with annuities is that they often carry a penalty for withdrawing principal for some years after you invest in them. You should find out if the annuity you’re considering has such charges before you invest. Further, you should have sufficient liquidity elsewhere. This will lower the probability that you’ll need to make a withdrawal, and thereby incur a penalty. A penalty is only on lump sum withdrawals, not for taking income.

So despite what you may hear, I believe that annuities are smart investments for many investors. Here’s why:

  • You can receive a lifetime of income that cannot be outlived.
  • You can arrange for periodic payments over your lifetime or over the lifetime of you and another person whom you designate.
  • Payments continue even if they exceed your principal and earnings.
  • You, not the insurance company, maintain control of your money.

For more information, read what the SEC says about annuities. And by all means, call our office today if you have questions about annuities or need help creating a smart financial plan.

Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. An investment in the securities underlying a variable annuity involves investment risk, including possible loss of principal. The contract, when redeemed, may be worth more or less than the original investment. The purchase of a variable annuity is not required for, and is not a term of, the provision of any banking service or activity. Guarantees are backed by the claims-paying ability of the issuer.

Variable annuities are sold by prospectus only. Investors should carefully consider objectives, risks, charges and expenses carefully before investing. The contract prospectus and the underlying fund prospectus contain this and other important information. Investors should read the prospectus carefully before investing. For a copy of the prospectus contact your financial advisor. Thanks!