Variable Annuities: Pros and Cons

Pros of Variable Annuities

Variable annuities can be a terrific investment to secure retirement income, especilly in good financial times with a burgeoning stock market. In contrast to fixed annuities, the money in variable annuities can increase.

Pros

As the stock market goes up, the money in the annuity account would also increase. This means that policyholders can assume that they will get more money in the future. Policyholders also pick the bonds, stocks, and mutual funds in which they want to invest providing the utmost ability to self-direct their retirement investing. Policyholders who are savvy investors therefore have the opportunity to make a lot of money with a variable annuity.

Variable annuity policyholders are not subject to minimum distribution requirements, which is excellent for those who have a lot of assets or have a family history of long lives. Similar to a 401k or IRA, the money that is put into a variable annuity and any interest accrued is not taxed until it is withdrawn. The majority of annuities also come with a death benefit, and this is also true of variable annuities, which guarantees that loved ones will get some money in the event that a policyholder passes away prematurely.

Tax deferral – The ability to defer taxes on an investment is a positive with valuable annuities. Most attention focuses on the higher growth attained when investment gains accumulate free of annual taxation. This is not the only benefit of tax deferral. For example, recent academic studies suggest that asset allocation, rather than active management, is the best tool for maximizing rate of return. Tax deferral allows rebalancing of portfolios without creating a taxable event. Another advantage of tax-deferral is that, in principle, the annuityholder is much more likely to face lower tax rates in retirement than while working

Cons

A great number of annuities have add-on policy attachments (or riders) that can cost policyholders additional fees. There are many companies that do not require these riders, however, a significant number do. Another negative is that if the money in the annuity decreases, so will the total worth. In contrast, policyholders who have fixed annuities do not need to worry about this. A third negative aspect to variable annuities, like with IRA's, is that policyholders cannot withdraw money from the account until they are 59.5 years old. If a policyholder does make an early withdrawal, a 10% penalty assessed.

In addition, a policyholder will not get a lot of income if he/she wants to draw payments immediately. If a policyholder is to get any kind of meaningful income from a variable annuity, it is better to put off the date that they begin receiving payments in order to get the most financial advantages possible.

Taxation as ordinary income upon distribution – Unlike mutual fund redemptions, variable annuiy investment gains, according to the Comprehensive Annuity Guide are taxed as ordinary income upon distribution. Since income tax rates currently exceed the long-term capital gains rate of 15%, this wipes out some of the tax-deferral gains of variable annuities.