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?
A tax-deferred variable annuity is a very bad idea. First of all, if you check the fees, they tend to be unusually high. Advisors who recommend them usually get up-front kickbacks from the providers which is why they are so often recommended. Also, these will usually significantly underperform ordinary diversified portfolios over any period of time. There will also be all kinds of restrictions and fees for "early withdrawals" which in some cases means taking your money out any time over the next twenty years.
There is also very little advantage to deferring taxes now that the Republican tax bill will become law in 2018. Tax rates will be low, and will probably rise in 2021 when the Democrats likely regain control of the House, Senate, and U.S. Presidency. You want to be accelerating as much income as possible into 2018-2020, not deferring it, since a huge budget deficit means that whenever higher taxes are enacted again they will likely remain high for many more years.
A much better strategy is to set up a schedule for doing Roth conversions. This involves converting money in non-Roth 401(k)s and non-Roth IRAs into Roth IRAs. You have many years to complete this process, since you will not have required minimum distributions until you are both 70-1/2. You should set up a schedule for doing this starting in January 2018 when the tax rates will be lower. Whichever shares you convert from non-Roth accounts to Roth accounts will become tax-free after conversion, so convert whichever shares you think will climb the most in value over the next year or so. Convert as much as you can each year without putting yourself into the next major higher tax bracket.
Above all, be conservative now since U.S. stocks are near all-time record highs and are thus much more vulnerable to losses over the next two years or so.
Well, although I myself personally have had clients who have found that annuities are effective and the best tool for their retirement plan, I don’t believe that a Tax Deferred Variable Annuity is a good or useful option for the majority of investors and retirees. The reason I say this is because the fees are usually more expensive than just paying the taxes. This means you’re losing money, and control over your investments considering that many of these kinds of annuities will tie your money up for years. I would suggest buying tax-efficient exchange-traded funds. These stocks are not only low cost, but they are also traded easily and frequently every day. This way you can profit more, and you have more control over what you want to do with your money. I hope this was helpful in your journey to Plan Smarter and Live Better!
Understand that annuities come with high sales commissions, typically limited returns (that may barely keep up with inflation), and loss of principal with the highest payout option. A better option may be a moderately allocated ETF portfolio in an individual taxable account. An honest advisor can most likely manage your account based on your goals and time horizon for a much lower fee than the annuity.
Everyone has a different situation. It is hard to say what may be best without all the facts. The one thing I will say is not all annuities are created equal. If that is the route you decide to go make sure you understand all the details of the contract including fees.
A Tax Deferred Variable Annuity can be a good idea if you are in the absolute highest tax bracket and truly need to avoid any further taxable income for the next 10 to 20 years. Otherwise, I would advise put the money into a Taxable Account and invest in growth stocks that will provide tax friendly qualified dividends and capital gains. With a tax deferred variable annuity (VA) the investment income and captial gains are counted as ordinary income when withdrawn during retirement. Also, you have to wait until you are 59 1/2 to take funds out of the annuity without an additional 10% penalty. VA's will have a surrender charge for 10 to 15 years so should you need the capital during that time the surrender charge is a consideration. VA's can have some features that might make them beneficial for specific situations, I would have to know more about the specific contract to address whether these advantages would be present.
Another issue I have with VA's is the investment choices and changes. With a brokerage account, it is easy to take steps to keep the account well diversified for risk management. With a VA, there may or not be a way for you to make changes with your advisor, online or with an insurance company representative in a timely manner but in any case the choices you have for investment are limited.
Bottom line - caveat emptor.