“Tax deferral,” “diversification,” and “hedge against inflation” are all terms that carry positive messages among individual investors because they mean dollars invested are being maximized to fulfill long-term funding needs. They are all terms associated with variable annuities
. If they sound positive to you, ask yourself the following questions:
- Are you a taxpayer seeking a way to help reduce the impact of today’s high tax rates on your income?
- Have you “maxed out” your Individual Retirement Account (IRA) and 401(k) plan contributions for the current year?
- Do you desire the ability to control where your investment dollars are placed?
- Are you a retiree facing greater taxation of your Social Security benefits and wondering how you can protect yourself?
- Are you seeking a life income option, as well as a good hedge against inflation to protect the dollars you’ll need during retirement?
- Would a guaranteed death benefit give you an extra sense of security for your investment?
- If the answer to any of the above is “yes,” a variable annuity may be the solution you seek. It offers very distinct benefits over other long-term investment vehicles. It can help meet retirement savings needs either through a tax-qualified plan or as a supplement to other retirement funding plans.
- Variable annuities can offer you (the individual investor) exceptional benefits, including the professional management of mutual funds, some of the tax-deferral advantages of an IRA or 401(k) without contribution limits, and certain guarantees of the issuing insurance company, including the passing of your original investment, or cash value if greater, intact to a named beneficiary in the event of your death during the accumulation phase.
The Accumulation Phase
A variable annuity differs from a conventional fixed annuity
in that its results are based on the performance of the underlying mutual funds offered to and selected by the contract owner. Like a fixed annuity, however, a variable annuity can be paid for and put into operation on a deferred
The Payout Phase
While we all know the benefits of the tax-deferred accumulation of an annuity, one often overlooked feature in a variable annuity is variable payout
. If you have a fund manager who has performed well for you during the accumulation phase of the contract, why would you want to give that up to invest with someone else? Upon retirement or maturity of an annuity contract, you have three choices: a lump-sum distribution, which creates an immediate taxable event on the full amount; a systematic withdrawal program that requires withdrawal of earnings, which are taxable as they are received, before principal; or the election of a variable payout or a part-variable and part-fixed payout.
Variable Annuity vs. Mutual Fund
There are two very important advantages to the purchase of the variable annuity that the mutual fund purchase will not provide. First, during the accumulation period, money paid into the variable annuity grows on a tax-deferred basis. This means there is no current tax on the investment growth of the annuity fund.
Second, the variable annuity provides a lifetime annuity payout option
. Systematic withdrawals from a mutual fund do not ensure lifetime payments. When comparing variable annuities to mutual funds, remember to factor in insurance costs of the former; there will be mortality and expense fees associated with providing a death benefit guarantee and administrative services under the contract. Also, the liquidity provided by mutual funds and tax penalties associated with premature withdrawals from annuities should be considered, among other issues, when choosing between mutual funds and variable annuities.
In addition, a variable annuity is protected
property. The annuity cannot be borrowed against or pledged by you to creditors, except under certain limited circumstances. In addition, most contracts offer annuity options that will provide for your beneficiaries to receive an amount fixed by the contract, without waiting for probate, should you die prior to completion of annuity payments.
Consult your financial professional to determine if a variable annuity may indeed be the answer you seek to your tax and retirement funding questions.