Published August 2003

Is a variable annuity
right for you?

To have the money you’ll need for that comfortable retirement you’ve been working toward, your best move is to contribute as much as you can afford annually to your 401(k), SEP IRA, SIMPLE IRA or personal IRA accounts. But what happens if you hit the contribution limits on these plans? What other tax-advantaged investments are available to you?

One possibility is a variable annuity. However, before you purchase one, let’s review the benefits — as well as some of the disadvantages.

Some of the key benefits of a variable annuity include:

• Variety of investment choices. A variable annuity is made up of several separate mutual fund-type investments known as “subaccounts.” Typically, these subaccounts have different objectives — income, growth, aggressive growth, etc. You can divide your investment dollars among the available subaccounts to create a diversified portfolio.
• Tax-deferred earnings. You’ll pay no taxes on your variable annuity’s earnings until you start making withdrawals (which typically begin when you retire). Consequently, your money will grow faster than if it were placed in an investment on which you paid taxes each year.
• Guaranteed death benefit. As with many of these contracts, if you die before you’ve started taking withdrawals from your variable annuity, your beneficiary is guaranteed to receive a specified amount; at a minimum, this will be the amount of your purchase payments. Keep in mind, though, that guarantees on annuities are backed by the claims-paying ability of the issuing insurance company. Make sure you’re buying quality.
• Flexible withdrawal options. There are a number of ways in which withdrawals can be taken from your annuity. You can set up a stream of income that you (or you and your spouse) can’t outlive, or you can choose to take the money over a certain number of years.

As you can see, a variable annuity does offer some attractive features for anyone interested in saving money for retirement. But, as is always the case in the investment world, there are both pluses and minuses to the variable annuity story. Here are some of the potential drawbacks:

• Investment risk. The word “variable” means what it says: The value of your annuity will fluctuate up and down, based on the performance of your underlying investments. If these investments are of high quality, and you hold them for many years, you have a good chance of achieving exceptional growth. However, there’s no guarantee that your principal will increase — or even be preserved.
• Surrender charges. Some types of variable annuities require payment of a “surrender charge” (deferred commission) if you need to withdraw money from the annuity within a few years of purchasing it (typically six to eight years). These surrender charges decline gradually over time. (Note that some of these annuity contracts allow you to withdraw a small percentage of your account value each year, free of surrender charges.) Other types of annuities, known as “A-share” annuities, do not assess surrender charges on withdrawals because commissions are paid up-front at the time of purchase.
• Early withdrawal penalty. If you withdraw money from your variable annuity before you’re 59-1/2, you may have to pay a 10 percent federal tax penalty. This penalty may be assessed in addition to any surrender charges.
• Fees and expenses. When you buy a variable annuity, you’ll incur annual “mortality and expense risk charges,” typically in the range of 0.85 to 1.25 percent of your account value. This charge compensates the insurer for risks it assumes in issuing your contract. You’ll also have to pay administrative fees, as well as fees and expenses imposed by the individual investment subaccounts.

If you’re investing for the long term (and you can tolerate price fluctuations), then a variable annuity might be a great way to supplement your retirement savings — but don’t make any hasty decisions. By doing your homework now, you can avoid a lot of “wrong answers’’ later.

Eric Cumley is an investment representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 8,000 locations nationwide.

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