When is a Tax Deferred Variable Annuity a good strategy?
Me and my spouse are 45 and 47 years old. We both max out our 401(k)s and IRAs. Our 401(k) contributions make us on track for retirement. We have good liquidity. We have $200,000 to invest and our financial advisor is recommending a Tax Deferred Variable Annuity. What is your recommended strategy?
As with virtually all answers to these questions, I have to plead "Not enough information". A correct and useful answer would have to take into account at least the following:
1. What's your retirement time horizon; at what ages will your salaries end?
2. What annualized rates of return (ROR) & inflation are you using to determine that you're "on track"? What evidence do you have that your (or your adviser's) assumptions are reasonable? What backup plan do you have if you're wrong?
3. Do you have a sequence of returns risk strategy? This is the risk of a major market correction right after you retire and begin drawing down your savings.
4. The latest research shows that your chances of outliving your money are minimized if you "floor" your basic inflation-adjusted budget and then, if you have investable assets left over you aggressively invest those for the long term. See retirementresearcher.com
5. What is your debt picture? If you have high-interest consumer or mortgage debt it might make more sense to pay that down, or off, instead of investing in today's frothy market.
The variable annuity (VA) might make sense if it's being used to strategically deal with #3 & 4 above. But I think, as part of a flooring strategy, laddered indexed annuities with income riders would be less expensive and more effective. However, in the absence of a comprehensive plan, and side-by-side comparison of the best alternatives, it doesn't make sense to just buy a VA.
First, congratulations on maxing your retirement accounts! That's always a good goal and you've clearly prioritized that during your peak earning years.
It's really impossible for anyone to answer whether this is a good idea unless they had your entire financial situation. Let me try to arm you with more information to make a good decision:
1. There are very few situations in which an annuity makes sense. Very few. It's not to say they're terrible products in all cases, but given your age and savings rate, it's likely not worth using an annuity. You have plenty of time to save enough money to create your own income stream, which is the goal, right?
2. Annuities are often oversold because they pay large commissions. The percentages say your 'advisor' is likely making this recommendation based on how much money he/she will make on the product sale, not how it fits into your strategy.
3. Is your advisor a sworn fiduciary? Have they signed an agreement to that effect? Why not? Advisors that have a fiduciary responsibility and don't receive commissions magically stop recommending annuities.
4. Be very clear about the terms before you sign anything. Understand how it works, and how you can get your money out of the product if you want. Is it too hard to understand how it works? Then why are you buying it? Finance doesn't have to be complicated.
5. Finally, seek out a second opinion from a fee-only, fiduciary advisor. They are sure to look at your entire financial picture and give you an objective opinion, rather than force you into a product.
Annuities are a great way to make money -- if you are a broker. If you are an investor you are essentially buying an insurance policy coupled with an investment portfolio. Usually there are very high fees in the first year (sometimes around 5% or even more) and ongoing premiums and management fees that erode your returns. Also, most annuities have hefty penalties if you have to redeem them early. On the other hand, you get some tax advantages and possibly a guaranteed annual payout when you are old. Read everything carefully.
Thing is, with a little discipline (i.e., put your money into equity investments and don't touch them) you might wind up a lot better off in two decades if you do this on your own. At best, an annuity is an expensive way to force yourself to save. If you are the type of person who does not need that kind of external disciple (and it appears you don't, since you are doing the right thing in your 401(k)s), take a pass.
I am going to come straight over the bow on this one and say rarely is a Tax Deferred Variable Annuity a good solution. I suggest them in two cases. One, the person investing does not have the 'capacity' to understand investing but will at some point down-the-road need a stream of income. Two, I will suggest it when the person investing wants to grow their money but has almost zero emotional resilience for risk. When I do reccomend them I send teh client to someone else to buy it. Keep in mind, anytime you give an insurance company your money and in exchange they are 'guaranteeing' anything, you will pay for it. The rule of thumb is if you defer risk you pay for it.
I would highly recommend that not only do you go seek another opinion about what you should do with your $200k, but I would also go talk with a fee-only advisor who is not compensated to sell financial products and services. I don't know this is the case with your advisor, but I highly suspect the recommendation is more motivated by the commission check he or she will receive. It has less to do with what is right for you.
This is an excellent question and one many people are faced with on a regular basis.
Buyer beware...assuming this is not a no-load annuity you will want to know how long the surrender chanrge period is for starters. This is the time frame that you need to keep the investment without incurring significant charges. You should also know that if you are purchasing this product from a commission advisor their commission could be anywhere between 1-7% of your initial deposit.
Some other things to consider, when the time comes for you to begin withdrawing monies it will be paid to you in a LIFO format (growth first and principle after). The growth is all taxed as ordinary income so depending on when you begin withdrawals and your tax rate at that time, this could be substantially higher than paying capital gains rates. In addition, the annuity will operate with similiar rules to a retirment account that you will be penalized for removing the monies prior to age 59 1/2.
I would suggest that a variable annuity be your last resort, after exploring other options first, such as running an analysis of what the difference would be investing in the annuity vs. a taxable account. Should you still have the need/desire to invest additional monies tax deferred then I would suggest looking for a no-load variable annuity structure. This will give you the least expensive options for a variable annuity. These investment products are very complicated and you will want to make sure you understand what you are investing in prior to doing so. I would recommend reviewing these options with a fiduciary advisor and not a commissioned advisor prior to moving forward.
Best of luck with your investments!