I’ve heard variable annuities (VA’s) pitched as “safe” alternatives to investing in the stock market and as a safe way to get market like returns without the risk. This is malarkey of the highest order and greatest magnitude. There is nothing worse for investors and nothing that eats away at your wealth like VA’s. Hopefully you haven’t bought one of these toxic “investments.” If you have, I apologize I wasn’t there to stop you.
For starters, these are not investments. These are insurance contracts and their guarantees are only as good as the company standing behind them. And let’s not forget insurance companies can and do go bankrupt. If the company that issued your annuity goes bust, your contract may only be worth a doughnut and change.
VA’s are sold as a safe way to attain growth without market downside. In reality nothing could be further from the truth. These are insurance contracts with mutual fund investments (called sub-accounts) wrapped into the contract. The fees alone are money killers and cash burners that will eat you alive and bleed you dry leaving you with little upside potential.
Fees, fees and more fees; VA’s are notorious for the exorbitant fees they charge. One reason Wall Street corporations have to charge you large fees are so that they can cover the large commissions they pay their brokers that sell these products. Typically, the salesperson (i.e. your advisor) receives 6 to 10 percent of total dollars put into a VA in the form of a commission. In some contracts these commissions can run as high as 14 percent! For example, if you put $1 million into a VA, your broker may receive $100,000 or more for a single sale without doing much work other than perfecting the sales pitch. In other words, if you buy one of these, you are placing a BMW M6 Convertible in your broker’s driveway or helping put his kid through college.
It’s true that VA’s can have the benefit of tax-deferred growth, but ironically, many investors buy and hold these in their IRA (i.e. an account that already allows tax-deferred growth) defeating this very reason to buy the VA; analogous to holding two umbrellas in a rainstorm. Moreover, since withdrawals from a VA are considered income, any growth inside the annuity is taxed at ordinary income tax rates, not at the more preferable long-term capital gains rates.
If you have the ability, I would recommend getting out these as quickly as possible, and staying out of them. VA’s are like a bad marriage and divorce seems impossible, but through proper evaluation there are ways to get out. Annuity salesmen know how to sell these and make them sound safe and promising. Don’t believe their advertising and public relations. Wall Street companies spend billions of dollars to make us think they’re nice and they just want to help us out. They want us to think they have all the solutions. They don’t. Also, these are not a smart alternative to investment growth because whatever growth you receive will have to compete against the huge fees you will be paying to the Wall Street corporations.