Max's Investment World Stock Market Challenge
Variable Annuities--Not Right for Everyone
Keeping Uncle Sam away from your portfolio is all the rage these
days as more and more people set up and add to Individual Retirement
Accounts (IRAs) or defined contribution plans set up by employers--known
as 401(k) accounts.
Nearly as popular are variable annuities, which also allow investors
to defer taxes on investments. While putting the most you can
into an IRA or 401(k) plan is clearly a no-brainer, getting into
variable annuities definitely requires some thinking.
In the first place, a lot of people don't understand variable
annuities, violating the first rule of prudent investing: know
what you are getting into. The goal of setting up a variable
annuity is to defer paying taxes until you are older, usually
after you retire. At that time, you probably will move into a
lower tax bracket, thereby paying less tax on your investments.
Insurance and mutual fund companies sell variable annuities to
individuals who contribute money just as they would to an IRA
or 401(k) plan. The companies then take the money and give it
to money managers who invest it in stocks, bonds and other assets.
After some time, usually upon retirement, the individual cashes
in. The pay out is made over a certain period of years during
which taxes are paid. The amount of the payment, as the name
implies, is variable and dependent on the performance of the
investments. In addition, variable annuities offer heirs a death
benefit, just life insurance.
You should only consider variable annuities if you have maxed
out on your IRA and 401(K) contributions and still need and want
to get out of paying current taxes on dividends and interest
income from your stocks, bonds and mutual funds. Oddly enough,
many people buy variable annuities even though they have not
done this.
Variable annuities often have higher expenses than mutual funds.
They usually charge sales fees, annual maintenance fees and surrender
charges, which are incurred if the investor wants to cash in
early. Indeed it takes six to seven years for an annuity to start
becoming cheaper than investing in a regular (read taxable) mutual
fund.
But no-load mutual fund companies, such as Vanguard and T. Rowe
Price, have been aggressively getting into the market and are
expanding their market share by offering lower annual fees.
Bottom line: if you do want and need a variable annuity, look
for those with low expense ratios and good performance over five
years. Morningstar and other firms keep such data.
Go to $Idea Central for more
investment ideas!
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