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Pros and Cons of Variable Annuities

When you ask an independent financial advisor what he or she thinks about investing in variable annuities, you may see a frown appear on his or her face. On the other hand, someone who sells variable annuities for a living may be exuberant in extolling the virtues of this particular financial product. It is up to you to decide whether or not you should  invest your hard-earned money in a variable annuity. Be sure to examine both the positive and negative aspects of this product before you make any investment decision.


Money grows in a tax-deferred account

During the accumulation phase, your investment is not taxed. Depending upon the investments you have in your variable annuity, tax-deferred status may allow you to accumulate a larger balance when compared to an account that is not tax-advantaged. If you have maxed out other tax-deferred accounts, a variable annuity offers you another avenue for similar tax treatment on your investment.

Flexibility with how your money is invested

Variable annuities allow you to make investment choices. While you cannot buy individual stocks, you are able to choose investments that are similar to mutual funds to create the portfolio within your annuity. Funds, which are referred to as sub-accounts, are professionally managed. Your return is directly correlated to the performance of the sub-accounts. Most variable annuities offer a representative selection of stock, bond, and money-market type sub-accounts. Such flexibility allows you to align your investments with your risk tolerance.

Keeping ahead of inflation

While there is no guarantee of whether the stocks in your sub-account will go up or down in any given year, from a historical perspective, equities tend to outperform so-called safe investments like bonds and CDs. Variable annuities are long-term investments, and over time, you will likely do better than the rate of inflation.


High fees, charges, and expenses

The first thing that anyone who does not like variable annuities will tell you is to watch out for the high fees, charges, and expenses. If you need to withdraw money early from your variable annuity, you will normally be hit with a surrender charge. Surrender charges get progressively lower as you get closer to the end of the surrender period.

Variable annuities have a mortality and expense risk that may siphon roughly 1.25 percent off your annual account balance. Administrative fees that cover such things as record-keeping and sending out statements can be charged as a flat fee, or as a percentage of your account's value.

Your rate of return is further reduced because of the management fees charged to run the “mutual funds” in your account.

Choices of investments

You must choose among the investments offered for your particular annuity. If you decide to invest, you may have to settle for a fund or funds that do not particularly strike your fancy.

Tax treatment

While you do get the benefit of tax deferral, you do not get the benefit of deducting investment losses on your tax return. When you withdraw money, you are taxed at ordinary rates and not the lower capital gains rate. Consult with your financial advisor, tax advisor, or other financial professional before making any decisions that could impact your tax situation. 

Lack of liquidity

If you decide you made a mistake by buying a variable annuity, you cannot just ask for your money back. You will likely face surrender charges and if you have not reached 59.5 years of age, the government will extract a 10 percent penalty.