Q: I'm 43 years old with two kids. In 2009, I opened an account for a variable annuity with an initial payment of $10,000. I've been putting in $500 per month. I have no idea how it really works. All I know is it will provide me a pension for life.
I've heard rumors that a variable annuity is a bad investment, but every time I ask my financial advisor, he said not to worry and don't listen to those rumors. I need to hear from you before I go further and ruin my retirement plan.
A: First, do you think your current financial advisor is giving you objective advice? If he earns commissions on the annuities he recommends to you, your best interest is unlikely to be his top priority. And if you already believe he's withholding information, you can't be making good decisions regarding your financial planning. My first piece of advice would be to find an advisor who will put your financial interests first. That means requiring the advisor to act as a fiduciary. That also means not working with someone who earns a commission from the sale of an investment. You want to work with someone who is selling only their advice, not products.
As for variable annuities (VAs), it's hard to give specific advice since I don't know your full situation. In general, I don't recommend them as an investment vehicle. The negatives associated with VAs are:
- The insurance wrapper -- which provides tax-deferral and annuitization options -- is typically costly and reduces returns.
- The mutual funds offered in VAs are generally more expensive than their non-annuity equivalents.
- Very few VAs offer low-cost, passive investment options.
- VAs lack liquidity due to high surrender charges, meaning that if you needed to take out a lump sum, you're likely to be charged a penalty if you take it out too soon.
- Although there are tax-deferral benefits, you lose other tax-management options, such as receiving a step-up in basis, donating assets to charity avoiding all taxes, harvesting tax losses or paying a lower capital gains tax rate (taxable account) versus a higher ordinary income tax rate (from an annuity)
Since you already own a VA, consider the following steps:
1) Investigate whether the VA is appropriate within your portfolio.
2) Determine whether the existing VA has reasonable costs and appropriate investment choices. If the VA is inappropriate and the surrender penalties are non-existent or small, consider making a 1035 exchange into a lower-cost VA with passive investment options.
Finally, you mentioned the benefit of "a pension for life." There's an annuity product that can do that for you called an immediate fixed annuity or a single premium annuity (SPIA). It's the only type of annuity I'm in favor of as it provides the highest level of lifetime income for the lowest cost.
Essentially, you give the insurance company a lump sum of money and then receive monthly payments for the rest of your life. But you don't need to purchase it until you're ready for the income. In the meantime, investing your money outside of an annuity will provide better odds of having a larger pool of money to annuitize when (and if) the time is appropriate.
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