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The SEC Helps Explain Variable Annuities

Variable annuities are a good way to safely secure retirement income while having the potential to receive gains in the stock market.  They can be confusing products though and are not necessarily right for all investors.  Andrew Wang of Runnymede Capital Management recently published an article in the Huffington Post explaining the nuances of variable annuities.  In “10 Things The SEC Wants You to Know about Variable Annuities,” Mr. Wang points out that the SEC’s Office of Investor Education and Advocacy has helpful bulletins about variable annuities.  These include an introduction and the facts that they think you should know before purchasing a variable annuity.  The top 10 things to consider are summarized below.

Read your prospectus.  This holds true for all annuities as well as other types of investments.  Prospectus’ can be long, even hundreds of pages, so get expert help if you need to.  There are also some tips available to help you save time when you are reading your variable annuity prospectus.  You will find your fees and other charges, choices for your investments, surrender charge schedule, death benefit options, and much more in your prospectus.  Variable annuities should not be used for short term financial goals.  Most of these products have a surrender period of at least 10 years and could charge you as much as 9% for taking your money out early.  Variable annuities are best used for long term financial goals, like helping to finance your retirement.  Keep some of your other money easily accessible for emergency funds.

Your principal is protected with annuities, making them much safer than solely investing in the stock market.  But with variable annuities, you could lose your gains if the markets start to perform badly.  The trade-off for the potential gains with variable annuities is that there is a potential for loss as well.  Those who are risk averse might turn to fixed annuities instead.  Most people benefit from maxing out retirement savings plans like 401k’s and IRA’s before purchasing a variable annuity.  Annuities of all types are beneficial when they are used to supplement retirement income and bridge the gap between other types of income and your expected expenses during retirement.

Some variable annuities are pricy, while others are not.  Know all of the charges associated with your variable annuity so that you can make sure that the benefits you are receiving are worth the costs.  There are surrender charges, mortality and expense costs, charges for investment options, and added fees for riders like living benefits, death benefits, or long term care.  Also make sure that the salesperson isn’t receiving a commission that you believe is too high.  With variable annuities, it is important that you buy from an insurance company with a strong reputation.  Financial strength ratings from companies like Moody’s and A.M. Best are important to consider since your annuity payments are based on an insurer’s claims paying ability.  There is no FDIC insurance on these products, although many states guarantee a portion of annuity payments.

If deferring taxes is one of the reasons that you want to buy a variable annuity, keep in mind that you won’t receive additional tax benefits if you are buying it with money that is already tax-advantaged.  Annuities that are bought from a taxable account will receive tax deferral benefits.  You aren’t losing any tax benefits though if you do purchase your annuity with funds that are already tax-advantaged.  You can transfer from one variable annuity to another using a 1035 exchange.  Before doing this, make sure to compare both annuities and see if the fees and charges are close to the same.  Also keep in mind that you have to be past the surrender period of the first annuity and will likely begin a new surrender period with the second annuity.

Some variable annuities offer bonus credits.  While these are a good additional benefit, it’s possible that they come with higher surrender charges, expenses, and longer surrender time frames.  Weigh the costs versus the added benefits to make sure that you want these bonus credits.  They may be worth the added costs to you.  Ask the financial advisor selling you the variable annuity if the product is right for you.  It is their job to only sell you a product that meets your needs accordingly.  Get a second opinion if you think that something is not right in the terms or with the product itself.  Variable annuities can be complex, so make sure that you have a thorough understanding of the products before you purchase them.  Their benefits often outweigh their costs, but if you don’t find that to be true for you, another annuity might be a better fit.

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