The Drawbacks Of Variable Annuities

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The Drawbacks Of Variable Annuities

Variable annuities may sound like a slam dunk for investors as many brokers pitch them as providing a guaranteed income for life. However, many investors soon find out that their variable annuity contracts contain unclear terms and conditions, high annual fees, massive surrender charges, and illusory tax benefits. Investors are becoming more wary of these annuities, and data from FINRA shows that there has been a massive increase in complaints regarding variable annuities.

There are a number of factors that investors should consider when deciding whether or not to purchase a variable annuity. First of all, variable annuities are extremely complicated. At its foundation, a variable annuity is a contract between an investor and an insurance company in which the company agrees to make periodic payments to the investor. The annuity is called “variable” because its value changes depending on how investments (usually mutual funds tied to stocks, bonds, and cash equivalents or a combination of the three) inside the annuity perform. This may seem simple, but many investors have trouble understanding the inner-workings of various riders that guarantee living benefits with minimum roll ups and periodic step ups. Additionally, many investors fail to read the fine print of their contracts.

Secondly, often variable annuities are expensive, and many times they are not worth their high costs. Expenses relating to these annuities can easily take a 3% chunk out of the account value yearly. Thus, an investor would need to reach an annual return of 3% to break even. Say an investor’s variable annuity grew by 4% annually. The return on that annuity would only be 1% after expenses. Additionally, investors should know about surrender penalties, which apply to withdrawals made within a specified time period, usually six to eight years, after the annuity is purchased. The penalty is a percentage of the amount withdrawn and typically declines over time. Thus, investors who place a large portion of their assets in a variable annuity and find themselves needing cash within a couple of years of the contract can find that these penalties will hit them hard.

Finally, tax deferral is typically a poor reason for purchasing an annuity. Investments inside a variable annuity grow tax free and taxes on gains are paid only as money is withdrawn, but many other investment vehicles, such as IRAs and 401(k) plans, already offer tax-deferred growth. Furthermore, the tax-deferral benefits of a variable annuity may be overblown because investment gains in a variable annuity are taxed at the highest marginal income tax rate whereas investment gains in traditional brokerage accounts are taxed at the lower capital gains tax rate.

Of course, these annuities may be the right option for a number of investors, but it is important that they are fully informed on the risks and rewards of variable annuities before they purchase them.

If you or someone you know has lost money as a result of an investment, please contact Richard Frankowski at 888-741-7503 to discuss your potential legal remedies.

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