Why Variable Annuities Are Bad
When you save money for retirement, you have a multitude of choices. There are IRAs, 401(k)s and other retirement plans. Insurance companies offer a private contract called a variable annuity. Variable annuities allow you to invest your money into mutual funds and receive some of the benefits given to IRA and 401(k) participants. But many financial advisers will tell you that variable annuities are a poor choice. Learn why these contracts are not the most ideal way to save for your retirement.
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Function
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Variable annuities are like having a savings account with an insurance company. The difference is that the insurance company sets a contract term length. This means that the annuity has a maturity date, contract provisions, and penalties for breaking the contract.
Significance
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The significance of the variable annuity is that it allows you to invest your savings into mutual funds while receiving a tax break on your investment gains. Money grows tax-free in the annuity account. This means that you are receiving some of the benefit of a federally sanctioned retirement plan like an IRA or 401(k)..
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Disadvantages
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Contributions made to a variable annuity are made with after-tax money. Additionally, the money is taxed when you take withdrawals from the account. The insurance company also dictates the amount of money you are allowed to take from the account while you are within the surrender period. The surrender period refers to the maturity of the contract. For example, a variable annuity with a maturity of 10 years means that the insurance company dictates the amount of money you may withdraw within those 10 years. It also charge penalties if you withdraw more than the maximum allowed under the contract or if you cancel the contract.
Misconceptions
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A common misconception about variable annuities is that they represent an ordinary investment. While they are a savings vehicle for retirement, variable annuities are insurance products. They are not subject to the lower capital gains tax rates. Instead, you must pay ordinary income tax rates on your withdrawals.
Considerations
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Consider a variable annuity only if you have a need for insurance but do not qualify for life insurance. Variable annuities do have death benefit options that are weaker than life insurance death benefits, but the benefits are better than no benefits at all.
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