Variable annuities can be right for some investors and wrong for others. Before you consider buying one, make sure you understand all of its terms. Read the prospectus carefully. And consider these seven factors:
1. Liquidity and Early Withdrawals
Deferred variable annuities are long-term investments. You might have to pay extra to get out early. And any withdrawals before you reach the age of 59½ will bring a 10 percent tax penalty on top of the taxes you’ll have to pay on any gains.
2. Sales and Surrender Charges
Most variable annuities have a sales charge, typically based on the size of the assets. They also usually have surrender charges, which decline the longer you hold your shares. For example, a surrender charge could start at 7 percent in the first year and decline by 1 percent per year until it goes away.
3. Fees and Expenses
Variable annuities can be expensive. Sample annual fees include mortality and expense risk charges, which are charged to cover guaranteed death benefits, guaranteed income for life payout options or guaranteed caps on administrative charges. There are also administrative fees for record-keeping and other fund expenses including special features like stepped-up death benefits, guaranteed minimum income benefits and principal protection. These fees can reach 2 percent or more of the annuity's value. If a variable annuity offers features you don't need or want, reconsider whether it’s an appropriate investment for you.
Variable annuities do not offer all the same tax benefits that traditional 401(k)s or other pre-tax retirement plans offer. With a variable annuity, you cannot defer taxes on income and investment gains or reduce your current taxable income. That's why you should consider annuities only after maxing out contributions to your pre-tax retirement plans.
5. Bonus Credits
Many variable annuities offer bonus credits that can add up to 5 percent for each premium payment. To fund them, insurance companies typically impose high mortality and expense charges and lengthy surrender charge periods.
Variable annuities often include guarantees such as a death benefit or a payout option providing income for life. These guarantees are only as good as the insurance company that gives them. That’s why it’s so important to check out the insurance company’s financial strength. You’ll find a list of organizations that rate insurance companies on the SEC's website.
7. Variable Annuities within IRAs
This may not be a good idea. Since IRAs are already tax-advantaged, a variable annuity will provide no additional tax savings for you. It will increase the IRA’s expense while generating fees and commissions for the broker. Also, if the annuity is within a traditional IRA, you must start withdrawing income no later than the April 1 of the year following the year you turn 70½, regardless of any surrender charges the annuity might impose.
Learn more about variable annuities at FINRA.org
Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA).
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