Deferred variable annuities are a cross between mutual funds and insurance. They let you invest in mutual fund-like accounts that can grow over time, and they offer a guaranteed minimum, in case the investments lose money.
James Rogers, a financial planner in Exton, Pa., long avoided recommending deferred annuities, mainly because distributions are taxed at ordinary income-tax rates rather than lower capital-gains rates reserved for most other investments. But Rogers took a second look when insurers started offering generous guarantees. “I found they really had some appeal to clients who have lived through two serious bear markets in the past 10 years and have seen significant volatility in their portfolios,” Rogers says.
Rogers uses an annuity from Sun Life Financial that guarantees to increase the initial investment by 7 percent per year for up to 10 years and then allows annuity holders who are 65 to 79 years old to withdraw up to 5 percent per year from that guaranteed base amount (or from the actual investment account balance, if it is higher) for life. If you invest $100,000, for example, it would be worth $170,000 after 10 years, at which point you could start withdrawing $8,500 per year.
In addition to offering investors both guaranteed income and a chance to let their account balances grow, deferred annuities are more flexible than immediate annuities, which generally require you to lock up your investment for life. You can cash out of a deferred annuity at any time, although you’ll generally pay a hefty surrender charge if you do it in the first seven years or so.
Unfortunately, annuities with guaranteed minimum withdrawal benefits aren’t as good a deal as they were even a few years ago. After ratings agencies expressed concerns over insurers’ ability to make good on their promises, many companies scaled back their guarantees and increased fees for new policyholders. When you add up the total cost of insurance, underlying investments and added guarantees, most deferred annuities cost between 2.5 percent and 3 percent of your initial investment amount annually.
Many insurers also curtailed the investment options and now require you to invest a portion of your portfolio in a balanced fund rather than keeping all of it in stock funds. That minimizes their risk — and limits your potential gain.
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