Why Choose a Variable Annuity for Retirement

No matter what the economy, trying to select the right investment is a problem. A good mix of investments is always the answer. Many people select mutual funds for this reason, however, many people express an interest in variable annuities for various reasons. These are tax-sheltered vehicles, which contain mutual funds on the interior. A disadvantage is if you take the funds out before age 59 ½, you face an Internal Revenue Service penalty. There are advantages to a variable annuity, however.

Variable annuities are relatively new investments. TIAA-CREF, or Teachers Insurance and Annuity Association-College Retirement Equities Fund, created the first variable annuities for teachers in 1952 and John D. Marsh took it to the public when he founded VALIC, the Variable Annuity Life Insurance Co. The early variable annuities were laden with charges. You signed a contract for specific payments and paid all charges for the entire contract first. Most of the first variable annuities had three funds, a stock fund, bond fund and money market fund.

Today, the variable annuity is not like its early predecessor. Often there's no upfront cost for the product but a deferred sales charge if you remove the funds before the end of the surrender period. The host of mutual funds on the interior and guarantees make it quite appealing. You can have an annuity that's part of a retirement program like an IRA or 401(k). It's a qualified annuity in that case and you have to follow all the rules of the IRA or other pension plan . If it's not used to fund programs of this type, it's a non qualified annuity.

One major advantage of the variable annuity is the tax-sheltering of investment growth. You get to deduct from your income if you put money into a traditional IRA investment. However, you pay taxes on those funds when you remove them. You also must remove the funds before 70 1/2. When you invest in a Roth IRA, you don't get a deduction but don't pay any taxes on the growth when you remove it. You receive tax-deferred growth in an annuity but pay taxes only on the growth when you take it out. There is no requirement to remove the funds.

Some places size counts. If you're saving for retirement and maximized the amount into a company sponsored plan, a variable annuity is perfect as an investment. There's no limit on the maximum amount of investment each year, unlike IRAs.

Variable annuities often have several different fund families on the interior. Mutual funds don't charge you additional loads if you switch among the funds in the fund families. However, if you move to another family of funds, you'll pay a new load. Variable annuities allow you to switch freely between the families of funds they have in their interior with no additional cost.

Moving you money in a group of blended funds is important to maintain balance of your asset allocation selection. If you move your money from one non-qualified, non IRA, mutual fund to another, regardless of whether it's in the same fund family, you'll pay taxes on any growth you experience. Since the variable annuity is tax-sheltered, the same movement of mutual funds inside a variable annuity doesn't trigger a taxable incident.

If you annuitize a variable annuity contract, you'll have a payment for life no matter how long you live but have no access to the principal. Many of the variable annuities also have living and death benefits. If you purchase a living benefit guarantee, the company guarantees you'll either receive a specific amount after an agreed upon period or can take a certain percentage of funds and never run out of money but still have access to any principal. Death benefits guarantee that you're beneficiaries will receive a specific amount of funds.

Variable annuities are not for everyone but they are an excellent selection for those that want the potential growth of mutual funds without as much risk. While record keeping for taxes is incredibly easy compared to mutual funds and stocks, there is also a downside. The growth of the funds are taxed at regular income levels and not subject to the capital gains taxation, which is more favorable. However, the tax-deferral more than makes up for the difference in the taxation of the growth.

Sources:
Securities And Exchange Commission : Variable Annuities, What You Should Know
Resource Center Library: The Evolution of Variable annuities
FDIC: Consumer News: Annuities For Retirees, What you Should Know
Personal Experience: I've been a licensed financial planner, stockbroker and insurance representative from 1979 until my retirement in 2007. For several years, I was one of the national leaders in sales of variable annuities for Pacific Life and AXA.