Variable annuities: pros and cons

The series of products and services offered in today’s financial markets are enough to confuse experts, and few products can cause so many controversies in public and professional forums like variable annuities. Many brokers and planners see them as indispensable retirement planning tools, while other financial experts warn consumers to avoid them at all costs.

There is no black and white answer to this question, but before making a decision, you need to understand the pros and cons of these investments.

Advantages of variable annuities

  • They are not subject to contribution restrictions.

  • The money in them grows with deferred taxes.

  • Many states protect them from creditors.

  • They are exempt from probate.

Disadvantages of variable annuities

  • They may end up generating a lot of taxes.

  • They usually charge high fees.

  • They are so complex that many people who own them don’t understand them.

How variable annuities work

One of the problems with variable annuities is that it is difficult to understand how they work.

As for what they are, a variable annuity is a type of retirement account. The owner of the account has an investment fund designed to provide a fixed monthly income after retirement, the amount of which is affected by fluctuations in the value of the investment selected by the account.

In terms of complexity, variable annuities may be second only to variable life insurance. They are similar to their fixed and indexed cousins ​​in that they are issued as contracts in the form of deferred tax, whether they are placed in an individual retirement account (IRA) or another retirement plan with deferred tax.

For distributions made before 59½ of the contract owner, there is an early withdrawal fine of 10%, except for death, disability or other factors.

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However, the unique thing about variable contracts is that they provide a set of pre-selected mutual fund sub-accounts into which you can allocate premium payments. As the value of the fund rises and falls with the market, there is no guarantee of principal.

Most variable products also include life and death benefit add-on clauses to guarantee a minimum account value or income stream (see below).

However, even this information is not enough for you to make an informed buying decision. You also need to understand the advantages and disadvantages of these unique products.

In the long run, variable annuities can provide excellent returns, but it is wise to understand the tax treatment of such financial products before investing.

Advantages of variable annuities

Variable annuities can provide a package of benefits that are largely unmatched by any other type of financial product on the market today. Their main selling points include:

Unlimited contribution

As mentioned earlier, there is no limit to the amount that can be deposited in a variable annuity. For this reason, they are very popular with wealthy investors who are looking for tax havens. (Most operators set limits on initial purchases.)

Tax deferred

Like all other forms of annuities, variable annuities increase year by year on the basis of deferred taxes. Distribution shall be taxed in the year of distribution.

Insurance protection

Today, most variable contracts provide a series of life and death benefit add-ons that promise a guaranteed income stream or minimum account value.

The life benefit additional clause pays a guaranteed income stream based on the assumed guaranteed growth rate of the sub-account. Even if the sub-account is lower than this growth rate, you will still receive this expenditure.

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A typical death compensation additional clause promises the beneficiary the largest of three factors: the current contract value, the highest value on the anniversary of the contract, or the value based on a guaranteed assumed growth rate.

The potential for excess returns

People who deposit money in a stock sub-account and store it there for 20 years or more may see that their investment returns are higher than any other type of annuity.

Most variable contracts also provide basic fund management services, such as periodic rebalancing.

The fixed accounts available in many variable contracts are usually higher than the interest rates offered by comparable fixed products.

Avoid probate

Like fixed annuities and index annuities, variable annuity contracts are unconditionally exempt from probate. This enables beneficiaries to quickly obtain funds.

Creditor protection

Although this benefit varies from state to state, many states provide that creditors cannot attach funds deposited in variable or other types of annuity contracts. For example, Florida provides such protection.

Initial bonus and high guaranteed interest rate

Many variable annuity contracts will pay an instant bonus for the money paid into the contract, or they may provide a dollar cost averaging plan, pay a high fixed interest rate for the initial balance, and then transfer the money to a set period of time in a sub-account of your choice , Such as 6 months or 12 months.

Disadvantages of variable annuities

Despite its versatility, variable annuities are not available to everyone and do have some practical limitations.

Poor cost basis

Unlike stocks or other securities, the cost basis of a variable annuity will not increase upon inheritance. The beneficiary will pay taxes on the entire contract value added from the date of initial purchase.

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Poor tax treatment

Although taxes on variable contracts are deferred to retirement, they impose the same 10% early withdrawal penalty as traditional IRAs and qualified plans.

All distributions of these contracts are taxed as ordinary income, unless the contract is placed in the Roth IRA.

Similar long-term investments in index funds that do not pay dividends may produce similar growth, but with total liquidity and lower long-term income taxes.

High cost

Variable annuities are one of the most expensive financial products on the market. They are accompanied by countless fees and charges, including mortality and expense fees, mutual fund sub-account management fees, contract maintenance fees and other miscellaneous expenses. Some contracts charge transaction fees after a certain number of transactions within the contract.

The life and death benefit additional clause also subtracts regular expenses from the contract balance.

Most contracts also come with a large back-end surrender fee plan, which may not expire in 10 years or more.


As mentioned earlier, variable annuities are one of the most complex financial instruments available today, and their marketing and understanding of them is often poorly understood by salespeople and consumers.

Bottom line

Variable annuities can provide you with benefits that require multiple other types of investments and account combinations to replicate. However, you need to be thoroughly educated about their shortcomings.

The value of these products can only be assessed in the context of your tax situation, investment and retirement goals, and time frame.


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