Annuities - Part X: Variable Annuities

Variable annuities allow you to invest in stocks and bonds with an insurance wrapper and death benefit and the option to, at some late date, take a monthly benefit.

No guarantees on investment returns. Losing money is a real possibility but the insurance company offers a "floor" usually. Only fixed annuities guarantee a return rate.

Annuities are not free! The fees are added on to whatever the fees of the underlying mutual funds or other investments offered happen to be. And when you add on any additional features, like the four typical ones below, more fees are added. They are not usually enormous fees (but it is important to shop around) - for example, ".25% - .60%" - but over 20 years, .60% may be a 12% reduction in the ending balance amount, so the costs are not unimportant.

But, on the other hand, you are paying for features that regular index funds, mutual funds or other investments do not provide (so ask if you need these benefits):

(1) a death benefit (you may not need if you have no one depending on your income or you have saved and invested enough resources of your own);

(2) optional income for life (you may not need if your basic needs are covered by a pension, social security or other sources with a reasonable 2-5% of the balance as your withdrawal rate);

(3) tax deferral (you may not need if you have retirement funds like IRA's and a qualified retirement plan); and

(4) no RMD's (that is, required minimum distributions which, if you qualify for the ROTH IRA, also has no RMD's).

And the features, at extra cost, are:

GMWB - Guaranteed minimum withdrawal benefit (if retired or near retirement of 5, 10 or 15% typically); provides a way to get to that lump-sum money you gave the insurance company (liquidity) without annuitizing (taking a monthly payment).

Nice, you should consider this feature but, remember, none of these benefits come without an additional fee (think "expense ratio" in mutual funds).

GMIB - Guaranteed minimum income benefit (for example, 10 years to retirement or more); lifetime minimum income amount (to help you sleep at night knowing there is a base amount you will never lose). But, again, if you have to annuitize to get at your money, then this can be a disappointing return rate when all is said and done.

Insurance companies like to say your investment is guaranteed to "double", for example, in 10 years (which is a rate of return of around 7%), but then, surprise, you can't then take the money and run. It is not "yours", it is with the insurance company, and the only way to get at that "doubled value" is to take a monthly payment at some ridiculously low payout rate of, for example, 2.5% or so. Quite misleading and unfair but you now know the questions to ask.

GMAB - Guaranteed minimum accumulation benefit (annuity monthly payment is deferred for a set period but set at some rate of increase; this has nothing to do with your rate of return though).

I am so frustrated with insurance sales people stating a "guaranteed rate of return" when it is really a return of some of your own money. Again ( see other posts), do not fall prey to this nonsense. Variable annuities do not guarantee a rate of return since you are deciding how to invest the money.

Rule #3: If the annuity is not described honestly to you, then possibly disregard that product and that person. If you don't know, see an independent financial planner from NAPFA. (You would do this, hopefully, if you were buying a used car, right?)

GLWB = Guaranteed lifetime withdrawal benefit (kind-of like the GMWB feature with a twist); if you never take any withdrawals, then you may get to combine this with a GMAB. Oh boy!