Tuesday, August 6, 2013

Variable Annuities

Those of you with whom we have discussed variable annuities know that we at Paragon Financial Advisors are not fans of variable annuities. Our basic reasoning has been that variable annuities usually have high fees (for the insurance costs in addition to fund management expenses), required holding periods to avoid significant redemption penalties, and thus lower investment returns to you (the annuity holder). They also turn gains on investments that could potentially taxed as capital gains into gains taxed as ordinary income.

 The Wednesday, March 13, 2013 Houston Chronicle carried an excellent article by nationally syndicated personal finance writer Scott Burns. We would highly recommend you read the entire article at his website that can be found HERE . To pique your interest, we will quote some of his comments here to give you a general flavor of his opinion of variable annuities and with which we completely agree.

“According to the Morningstar variable annuity database, a typical VA contract carries insurance costs of 1 percent to 1.25 percent.”

 “…the fee burden becomes punitive in a low rate period. Over the last five years…the Vanguard Total Market Index (a proxy for all U.S. stocks) returned 2.18 percent a year. So … with an insurance expense of 1.1 percent a year, the cost of the insurance wrapper was 50 percent of your return.”

“…it would have been a bit worse if you had invested in the Vanguard 500 Index (a proxy for domestic large cap stocks) because … its return over the last five years was 1.57 percent, indicating a 1 percent insurance wrapper cost would have taken 64 percent of the return.”

 “The return from a variable annuity is taxed, upon withdrawal, at ordinary income rates.”

“Much of the return from a broad index fund … will be taxed at the capital gains rate. …now 20 percent, up from 15 percent last year.”

Mr. Burns is a proponent of indexing and he also discusses the performance issues associated with variable annuities vs. indexing. Anyone considering the purchase of a variable annuity will find this discussion a worth while read.

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