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Pros & Cons of Variable Annuities in a 403B Account

Accounts called 403(b) often are referred to as "tax sheltered annuities." These annuities are used primarily for educators. An annuity is a private contract issued by a life insurance company. These annuities help you save money for your retirement. But make sure you understand the pros and cons of investing in a 403(b) tax sheltered annuity.

  1. Identification

    • A variable annuity inside of your 403(b) account uses mutual funds to generate the interest earned in the account. This is in contrast with a fixed annuity, which uses a fixed interest rate set by the insurer. The account balance can fluctuate according to the value of the mutual funds.

    Significance

    • The significance of using a variable annuity in a 403(b) account is that the investment in mutual funds functions just like ordinary mutual funds, but with an insurance component. The variable annuity might offer a minimum death benefit guarantee that adjusts upward as the annuity account balance increases.

    Benefits

    • The benefit of a variable annuity inside of a 403(b) account is that you can convert the variable annuity to a guaranteed income when you retire. The variable annuity also gives you the benefit of investing in mutual funds combined with its insurance functions, like the death benefit options of the annuity.

    Disadvantages

    • The variable annuity is more expensive than a direct investment in mutual funds. This is because the variable annuity has a policy charge on top of the normal fees of the mutual funds inside of the annuity. Additionally, because the mutual funds are inside of the annuity in the 403(b) account, interest earnings are treated as investment income instead of capital gains. This means you are taxed at the higher ordinary income tax rates.

    Considerations

    • Consider other retirement account options for your retirement such as a Roth IRA. Roth IRAs allow after tax contributions and give you the benefit of guaranteed income for life plus the tax-free distributions of the Roth account. Additionally, consider a different investment product or a direct investment in mutual funds to avoid the additional costs of the variable annuity.

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