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Posts Tagged ‘Death Benefit’

Variable annuities are inherently one of the most confusing of all the annuities in the market place. There is no doubt about that in my mind. They have many pitfalls and risks and if you don’t understand them, you are likely to get involved with an annuity that has high fees and horrible performance as well.

Now, don’t get me wrong, there are people who have held their variable annuities throughout the good market years and have done quite well. I would venture to safely guess that they would have done better outside the same variable annuity. And it’s a pretty safe guess. Also, there have been people who have invested money in a variable only to die with market losses and to have their families become whole by benefiting from the death benefit. IT’S NOT ALL BAD. But it’s mostly far from good. I can comfortably say that variable annuities do have some benefits, however, there are only a very few specific times where they fit in a client’s portfolio.

So with that said, let me talk briefly about the living benefit…the 7% guarantee. Everyone who calls asks me is it too good to be true. IF YOU HAVE TO ASK IT PROBABLY IS. Think about it, when the market interest rates are 3% and 4%, do you think the insurance companies just want to be nice and offer you a 7% return on your money? Do you honestly thing they can afford to offer you a rate of return that is that much higher than the market? The answer is NOT A CHANCE. They don’t get to be the big bad insurance companies by giving away money. And they don’t get to be that profitable by not being prudent about giving away money.

There are strings attached to this benefit. You must understand what the risks are and fully be aware of what the insurance company is doing to give you this ’7% guaranteed return.’

And just be aware, things aren’t always as they seem. In particular, when you get an offer for one of these 7% guarantees, read the fine print. See it is what you have to do in order to be given your 7% guarantee at the end of 10 years. You’ll be surprised at what you have to do in order to get the guarantee. And you’ll also be surprised at how long it takes to get your ‘guaranteed’ money. And in the end, you’re going to find out that it is not what it seems.

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I’ve disliked variable annuities for many years because of their high fees and onerous surrender penalties. Now, low-cost variable annuities are available that slash fees and do away with the surrender penalties. Does this change my opinion on the use of variable annuities? Read on to find out.

There is $1.8 trillion dollars invested in annuities and a lot of that money is in variable annuities. To put this in perspective, there are $2.1 trillion in 401(k) assets. That’s right. There’s almost as much money in annuities as there is in 401(k) retirement programs!

As I’ve mentioned in previous articles on variable annuities (available at http://www.guardingyourwealth.com), variable annuities are sold because of two main features–tax deferral and a death benefit guarantee.

Tax-deferral is emphasized if you are investing non-retirement money. Instead of having to pay taxes on dividends, interest and gains each year, those taxes are deferred until you withdraw the money from the annuity.

This used to be an attractive option, but not since capital gains and dividend tax rates have been lowered to a maximum of 15%. You see, earnings withdrawn from an annuity are taxed at higher ordinary income rates. These can be as high as 33%.

In years past there wasn’t much difference between ordinary income tax rates and those on dividends and capital gains. Now, there is a substantial penalty when earnings are taxed as ordinary income. As a result, it can take decades before you really see the benefit of tax-deferral.

The other main selling point of variable annuities is the death benefit guarantee. Investors like the peace of mind knowing that even if the market drops substantially, their heirs will get at least what they initially invested when they pass away. This is used to entice investors to choose an annuity for their IRA where the annuity’s tax-deferral feature is worthless.

Unfortunately, investors had to pay through the nose for those benefits–typically 1.4% of the value of your account each year. On a $200,000 account, you would be paying $2800 a year. Over ten years it is likely those benefits would cost over $30,000. That’s some of the most expensive insurance you will ever buy.

Now there are new, low-cost variable annuities available from companies like Fidelity and Vanguard that lower the costs of these benefits. For instance, Fidelity offers one that charges