Variable Annuities: 7 Questions Before You Invest

Variable annuities are often touted as an ideal retirement investing vehicle, especially if you talk to financial advisors who sell them. Variable annuities can be a useful vehicle for retirement accumulation – but targets of the sales pitches (like you) often misunderstand annuities in general.

Is a variable annuity right for you and your retirement income needs? Ask these seven questions before buying.

1. What does a variable annuity do that I can’t accomplish with a different investment? I’m not anti-variable annuity but these investments are not the wonder drug proponents want us to believe. Ask the next person who makes a variable annuity pitch this and a few other questions and listen carefully to the explanation.

Maybe you will get a cogent, sensible answer. Maybe not.

2. Will I eventually annuitize the contract? One of the benefits of any form of an annuity: your ability to create periodic payments of income in retirement. This is the reason for the mortality and expense charges in every contract, the insurance company’s compensation for your option to annuitize the contract in the future.

If you don’t look to use this investment for retirement income, perhaps a variable annuity is not your answer. At the very least, find one with reasonable expenses.

3. Have I maximized contributions to my 401(k), individual retirement accounts and other retirement plans? In my experience, contributing to your 401(k) or similar workplace retirement plan and to your IRAs provide a better retirement savings vehicle than a variable annuity, if for no other reason than they usually carry lower expenses and no restrictions such as surrender charges if you withdraw money early.

I often put a variable annuity lower on the retirement planning list than investing in a taxable account, a strategy that of course varies based on each individual’s situation.

4. What are the expenses? Many variable annuities come laden with expenses that enrich the insurance company (and perhaps the person who sold you the annuity) but likely not you. Vanguard and others offer many lower-cost annuities.

5. What are my investment options? Years ago a “Saturday Night Live” skit referenced “bef,” which was almost like beef. In the variable annuity world, investment options are called sub-accounts that look, feel and smell like mutual funds.

They aren’t mutual funds and are generally pricier. Understand this investment as this vehicle fuels your accumulation in the variable annuity.

6. Are there restrictions if I want to move my money? As comics said on “Rowan and Martin’s Laugh-In” some 40 years ago, “You bet your sweet Bippy” that moving your money from a variable annuity does in most cases come with restrictions.

I understand the taxes and perhaps the penalties for withdrawing prior to you turning age 59½. Yet surrender charges on many variable annuities hold your money captive for as long as 10 years even if you find a better deal down the road. Make sure you understand any and all surrender charges and other penalties before buying into a variable annuity.

Better yet, avoid financial products with these charges.

7. Who stands behind the product? The “full faith” of the insurance company guarantees your annuity. Investigate the financial strength of this issuer, who is responsible for making annuity payments to you.

Annuity defaults are quite rare but do happen. Your recourse in that event is likely a regulator.

Variable annuities are a valid retirement planning tool. Just make sure you understand what you are buying and all underlying expenses. Buy the product for the right reasons, too, and not because you succumb to an aggressive sales pitch.

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Written by Roger Wohlner, CFP, a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Please feel free to contact him with your investing and financial planning questions. Check out his Financial Planning and Investment Advice for Individuals page to learn more about his firm’s services. Roger is active on both Twitter and LinkedIn. Check out Roger’s popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans. He is also a regular contributor to the US News Smarter Investor Blog and has been quoted extensively in the financial press including The Wall Street Journal, Forbes and Smart Money. Roger is a member of NAPFA, the largest professional organization for fee-only financial advisors in the country. All NAPFA Registered Advisors sign a fiduciary oath promising to act in the best interests of their clients.

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