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?
The value that Variable Annuity are sold upon is for increasing tax efficiency. If you looked to invest your $200,000 into Mutual funds in a regular investment account, you would receive taxable income in the form of dividends and capital gains every year. An annuity defers all income from the funds. However, you need to understand how they work:
- When you take a distribution, the earnings come out first which reduces tax efficiency.
- Like an IRA/401k, money that you take out is subject to a penalty if you are under 59.5.
- Fees are normally high.
I recommend that you create a portfolio of ETFs. ETFs are tax-efficient. The goal would be to hold them for at least a year to get long-term capital gain treatments. The investments would be liquid in case you needed money. You can build a portfolio for a small amount of fees.
If you are still interested in an annuity, some insurance companies (like Jefferson National) have no-load annuities. These are a decent compromise.
I hope this helps.
Run from the Advisor and never look back :).
Without knowing your income needs down the road it is quite difficult to proceed too far, but if your income goals is too early to determine then seeking an advisor who supports an active-tactical sector driven portfolio utilizing both stop orders and limit orders (to reduce both market risk exposure and incoming speculative risk) would be the plan. WHEN and IF that 'retirement' time comes closer, THEN an annuity (along with other income options) can be discussed. But run away from a VA. EXTREMELY high fees which range from 1.25-3.85% with ZERO guarantees on the working capital in most cases.
It does sound like you may be working with a broker or registered representative. In that case, they are not going to be portfolio managers and will rely on the typical 'buy and hold' which is extremely ineffective.
Annunites are never "bought", they are sold. I don't want to over generalize but in almost 20 years I have never found a reason to use an annuity. They have outrageous fees, inflexibility, and pay huge commissions to the broker or "advisor". Is your advisor a fee only fiduciary advisor? It sounds like he is not, and I think interviewing a couple of other people makes sense.
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.
Most annuities are expensive due to high commissions and have long surrender penalties, and I am NOT a fan. Did you know there are commission free annuities with no commissions and the ongoing fees are only .45% (45 basis points) annually with over 200 fund choices including professionally managed funds. You never hear of those because the salesman doesn't get a commission and there is no surrender penalties. You can put the money in one week and take it out the next without penalty. Even then, I am still not a fan because when you want to take the money out, it is income first (100%) then return of principal. I only use these for a like-kind exchanges when someone is trying to get out of an expensive annuity with gains when the surrender penalty is gone or minimal and they don't' want to pay the tax. Usually, these are inherited from their parents.
And if you manage your after-tax investments properly, you will pay a lot less tax than you think. Investing is about strategy not products. If you are being told about an "indexed annuity" that provides "most of the gains but none of the losses," you will not get anywhere near the "non-guaranteed illustration." You need to go by the "guaranteed illustration" and maybe add a percent or two. I am currently helping two people unwind indexed annuities who are unhappy with what they thought would happen. That's my two cents worth.
Hope this helps and best of luck, Dan Stewart CFA®