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A Fresh Look at the Variable Annuity

Many investing pundits criticize variable annuities as the ugly ducklings of the investing world. Critics often claim that the tax benefits may not be to your advantage, and that fees are expensive. However, for long-term investors who have taken advantage of their employer-sponsored retirement plans and are planning for retirement income, variable annuities remain a viable option. They offer investors a range of investment options with varying levels of risk, professional management, tax deferral, a variety of income payout options, and guaranteed death benefits.

"Taxing" Issues

One of the main bones of contention for critics of variable annuities is the issue of taxation. Income earnings from a variable annuity are taxed as ordinary income, rather than as long-term capital gains. However, because variable annuities are designed to help investors prepare for retirement, funds have the potential to grow on a tax-deferred basis. Therefore, any investment gain will accumulate free of current income tax, and will be reinvested, which can have a significant, favorable effect on the growth of your funds over the long term.

Variable annuities offer a variety of investment options. Based on your time horizon and risk tolerance, you can allocate your money to professionally managed subaccounts that invest in stocks, bonds, and fixed-interest instruments. The value of your annuity will fluctuate based on your payments and the performance of the underlying subaccounts. With a variable annuity, you may transfer funds between investment options free of tax, although company charges may apply. This favorable tax treatment can help you manage your money in the best interest of your retirement without worrying about the current tax implications of capital gains.

Unless you are investing in an annuity through a qualified retirement plan, your payments will be made with after-tax dollars and are not subject to contribution limits or income restrictions. Annuities that are part of a qualified retirement plan offer no additional tax deferral benefits.

The "Benefit" of Death Benefits

Investors with their sights set on retirement often factor their portfolios into their estate plans, and variable annuities offer guaranteed death benefits. In the event an annuitant dies before receiving annuity payouts, the chosen beneficiary(ies) will receive the greater of the value of the account, or the amount invested. Some variable annuities offer an additional feature—a "stepped-up" death benefit, which secures investment gains on a set schedule and guarantees a death benefit equal to the stepped-up amount.

For illustrative purposes, consider the following hypothetical example. Suppose Lynne Garfield purchases a variable annuity with an initial lump-sum payment of $50,000. In five years, her annuity is valued at $75,000 and the death benefit is stepped-up and locks in this gain. In ten years, it is valued at $100,000, when the death benefit is stepped-up again. Over the next two years, the economy struggles, and Lynne's annuity declines in value to $60,000. If Lynne were to die at this time, her chosen beneficiary would receive the annuity's stepped-up value of $100,000.

In addition to favorable tax treatment and guaranteed death benefits, variable annuities offer investors a variety of payout options, including potential income for life. With current trends indicating that individuals will be increasingly responsible for funding their own retirement, variable annuities provide investors with an opportunity to build and preserve wealth.

The principal value and rate of return in a variable annuity will fluctuate due to market conditions. Therefore, at any point in time, the value of the annuity contract may be worth more or less than the owner's actual investment in the contract. Guarantees are based on the claims-paying ability of the issuing company.

Copyright © 2003 Liberty Publishing, Inc. All rights reserved.


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