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Variable annuities have been sold by insurance companies to physicians and others for many years.
Variable annuities have been sold by insurance companies to physicians and others for many years. These high-commission products were marketed on the basis of capturing gains in the stock market in a tax-deferred envelope.
These investments involve giving an insurance company a lump sum of after-tax cash. You then may allocate the cash into different mutual funds investing in stocks, bonds, and other common asset classes. At a predetermined point in the future, you are allowed to make certain withdrawals, based on the earnings on the accounts after subtracting expenses.
In recent years, the insurance companies have added riders that allow guaranteed withdrawal rights of a certain percentage of the account regardless of the actual performance of the underlying investments. These companies also will guarantee a minimal investment return as a "floor," regardless of actual performance.The insurance companies do this by establishing two accounts: a "real" account that invests in securities and is used to pay expenses, and a "phantom" account that grows according to an agreed-on schedule and pays you your distributions. The distributions are usually a fixed percentage of whichever account is higher.
When you die, your family gets the balance of the real account. If that account performs poorly and/or has high expenses, little or nothing may be left for them to inherit. But if your account has good underlying performance and you happen to die early, there may be some assets to leave. Death benefit riders guaranteeing an inheritance also are available.
If the investments do much better than expected, the value of the account from which withdrawal percentages can be drawn increases. For example, one current annuity offers to double your original investment amount if the account is left untouched for 10 years, and then offers a 5% withdrawal rate for life on the doubled investment beginning at age 65. So $100,000 deposited at age 55 would translate into a guaranteed offer of $10,000 a year return for life beginning at age 65.
The addition of guaranteed living benefits enables insurance companies to sell these annuities as an investment and a type of insured income. The underlying expenses, however, usually are too high to realistically allow a decent return on investments. Therefore, these annuities should be evaluated only as sources of guaranteed income, including the assumption that the principal of the investments will not be touched beyond what is mutually agreed to when making the investments. Excess withdrawals of any type usually are penalized severely in terms of guarantee reductions and ultimate benefits. Look for the term "guaranteed withdrawal benefit for life" because this characteristic is vital.
In sum, variable annuities are now an option to consider as long as you think of them only as a guaranteed lifetime income stream. If a high return is your goal, you're probably better off looking elsewhere.
The author is a financial adviser and the principal of Wealth Care LLC based in Merritt Island, Florida. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you would like to see covered here, please e-mail email@example.com