Perhaps you’re still dancing the macarana, chanting the tune “Who Let the Dogs Out?” and wondering why you can no longer find “Who Wants to Be a Millionaire?” with Regis on the tube every night.
Then you, my friend, are probably also shopping for a variable annuity.
They once were hot, and now they’re not. But a lot of people still own them–to the tune of $886 billion–and many don’t know quite what to do with them.
Created to hook into the growth of the stock market, a variable annuity is a contract between you and an insurance company. It’s purchased with a single purchase payment or series of payments. The insurer agrees to make periodic payments to you, either right away or in the future.
These variable annuities, which are usually invested in mutual funds, built a reputation as a tax-deferred vehicle providing periodic payments for the rest of one’s life in addition to a death benefit.
Lately, however, less expensive retirement vehicles, such as 401(k) plans and Roth IRAs, have grabbed the spotlight. And the stock market has been a letdown, redefining “variable” as “continuous downward motion.”
Variable annuities attracted $30 billion in new money last year, only about half the amount they did in 1997, according to Variable Annuity Research and Data Service.
“The trend is out of variable annuities, a mature market with a declining amount of money flowing into it since the mid-1990s,” observed Cynthia Crosson, senior financial analyst with the A.M. Best insurance rating company in Oldwick, N.J. “A lot of the so-called growth isn’t growth at all, but money being moved around within an insurance company or from one firm to another.”
When a customer is lured to move money from a variable annuity at one insurer to another to gain some sort of bonus, it’s often not explained that he’ll also be starting a new surrender charge period of seven to 10 years, Crosson warned. Study the terms of every contract carefully.
“Fixed annuities grew by 36 percent last year while variable annuities were down, so variable is losing money to fixed because of the weak stock market,” said Dan Nahomey, managing editor for Insure.com in East Hartford, Conn. “Variable annuities should only be used by people who have done all the other things first, such as maxing out their 401(k) and IRA.”
On average, it takes about 10 years before you make a net return on a variable annuity because of the fees associated with it, Nahomey noted. It’s definitely a long-term investment.
It’s also expensive. A one-time sales commission, anywhere from 3 percent to 8 percent of each investment, is paid to a salesperson at purchase. The insurance company also deducts a percentage each year from your account.
You’re hit with large surrender fees if you make withdrawals in the early years, perhaps 12 percent of your balance if you pull out during the first year. That fee declines gradually each year until it vanishes in seven to 10 years. If you’re considering withdrawal, be sure to wait until surrender charges no longer apply.
If you’re under age 59 1/2, you’ll also pay a 10 percent IRS penalty plus regular income taxes on earnings in the withdrawal.
There are differences in contracts, so shop around if you decide to add a variable annuity to your retirement accounts.
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“Since it’s an investment vehicle tied to the performance of the stock market, a volatile stock market means volatile variable annuities,” explained Deborah Tucker, vice president with the National Association for Variable Annuities in Washington, D.C. “However, you can change your investment criteria within the contract to take advantage of market conditions or to move into fixed accounts or bond funds within the contract.”
As Baby Boomers mature, more of them are focusing on the contract’s guaranteed payout stream they’ll receive for life, rather than on its role as a savings vehicle, as they had in the past, Tucker added.
“The individual often buys a variable annuity from an insurance person coming to the house or buys it in a bank lobby,” said Chris Cooper, certified financial planner with Chris Cooper & Co. in Toledo, Ohio. “They’re sometimes sold to people for IRA rollovers, which is pointless because you’re sticking a more expensive tax shelter inside of another tax shelter.”
Often the potential customer is handed a “supermarket-style” variable annuity brochure with 50 different mutual fund accounts, fixed accounts and managed accounts, Cooper said, prompting a less than informed choice one may have to live with for a very long time.