Pros And Cons Of Variable Annuities

2008 July 30
by Kyle Bumpus
from → Annuities, Personal Finance

Regular readers will know I’m not such a big fan of variable annuities but I’ve gotten a few comments from readers that perhaps I’m a bit too harsh on them.  To that end, I’ve compiled a list of the pros and cons of variable annuities in an effort to be a bit more balanced in my presentation of them.  I’ve also written a fairly detailed post titled How To Use Variable Annuities The Right Way explaining a few specific circumstances where I think investing in a variable annuity really makes sense.

Pros of Variable Annuities

  • Deferred taxation – You don’t owe anything until you cash it in
  • (Often) some sort of guaranteed minimum return
  • No contribution limits, unlike other tax-advantaged accounts such as IRAs and 401Ks
  • You can choose to annuitize your account at retirement, guaranteeing an income stream for as long as you live with no tax consequences
  • No Required Minimum Distribution requirements, which can be a big plus if you have a large estate or come from a long-lived family
  • Ability to borrow against the value of your annuity (for a price)
  • Include a death benefit, ensuring your heirs receive some minimum amount should you die early
  • UPDATE: Annuities have certain positive asset-protection characteristics in some, though not all, states.

Cons of Variable Annuities

  • Gains taxed as regular income and not at the lower capital-gains rate
  • Subject to 10% penalty if you withdraw gains before age 59 1/2, just like retirement accounts
  • Generally higher expenses than their mutual fund counterparts
  • Often have confusing terms and are hard to understand for the average investor
  • Value dependent on the claims-paying ability of the insurance company in question.  If your insurer goes out of business, so does your money.
  • Almost always come with significant surrender fees if you change your mind within a specified period, 7 years on average
  • Death benefit usually far too expensive to be worth it, unless you happen to die fairly young

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7 Responses
  1. 2008 July 31

    Very well balanced and reasonable comments on the pros and cons of variable annuities. I have been in the insurance industry for over 40 years and while a great fan of annuities, every time I would study the ins and outs of variable annuities the conclusion reached was that the benefits never matched the fees and limitations of the contract.

  2. 2008 October 6
    Jase permalink

    I would have to think the living benefits offered on some of the more recent VA’s are a bit more attractive to investors now after the 30% drop of the DJIA. Not a cure-all for sure but for lifetime predictable income they do have a place for some portfolios. Prudential offers one with a 7% annual with daily market lock until the first withdrawal ( then that goes to quarterly market lock) so someone who may be able to go 7-10 yrs before taking an RMD or other distribution may be suited for it. Just my opinion.

  3. 2009 July 2

    What you fail to mention is that on the guaranteed income side of the Variable Annuity there are no expenses whatsoever all returns are net as are withdrawals. Prudential has a rider that locks in the highest day of your portfolio while in the accumulation stage in addition 7% net is credited to the income side in down years guaranteeing that you double your money in 10 yrs or less. Clients who buy this product are building a guaranteed investment that down the road will provide a lifetime of income. The costs come from the actual investment and only affect the death benefit or a surrender. Assuming someone were to go into the Prudential with the HD7 rider and the market had a negative return for 10 yrs straight the client would be guaranteed that the investment doubled. $100,000 invested in 10 yrs is worth $200,00 at this point client can begin an income stream of 5% a yr on the guaranteed highest achieved value. Personally I don’t see an investment that can even compete. With my program I don’t care the expenses come from the actual balance because I am only interested in providing a lifetime of income to myself and my spouse, whatever is left the kids can fight over. In the same scenerio $100,000 invested in a growth mutual fund that loses for 10 yrs would be worthless and no way to get a lifetime of income based on a minumum of $200,000.

  4. 2009 September 3

    This is one of the most balanced reviews of variable annuities that I’ve come across. Good to find straight information with no spin in either direction. I do want to point out one little thing.

    “Value dependent on the claims-paying ability of the insurance company in question. If your insurer goes out of business, so does your money.”

    The above is listed as one of the cons of variable annuities. It’s only partially true, much as it is for deposits in a bank account. State guaranty funds cover a portion of annuity and life insurance holdings in the event of a company default. It seems to me to be similar to FDIC or SIPC protection.

    It’s also my understanding that many people have know idea that state guaranty funds exist, because insurance agents and other financial advisors cannot mention it during the sales process unless asked about it.

    Some more info can be found at:

  5. 2009 September 21
    Bob permalink

    GK, this is a great product. I have it myself. You did a nice job representing it here. The other way to combat some of the cons is to consider converting part of your IRA into the annuity (rather than post-tax income), given that you can’t touch till 59 and 1/2 anyway, you’ll avoid any sort of surrender charges. I agree that the actual balance is less important, its the guaranteed withdrawal balance that matters. If you want to leave an inheritance, buy a little insurance. Also, after 10 years its a guaranteed 200%, after 20, 400% and after 25 years a 600% return that your annuitized income stream is predicated on if you don’t touch it.

  6. 2009 October 15
    Ralph Santillo permalink

    Is a va appropiate for a 65 year old who could wait about seven years before starting a withdrawal program.

  7. 2013 March 5

    Know what I’d like to see? Ready availability of the terms and costs of VAs. Since they are insurance products, they are not subject to the same disclosure rules as mutual funds or other investments.

    I’d like to get the ‘prospectus’ (I know, it’s not really called that) without having to find a local insurance agent, since legally, the out of state ones aren’t permitted to send me anything. Just let me download it.

    I’d like to know the net return after all fees with an S&P fund as the chosen underlying investment. That way, I can judge whether the product is worth it.

    Jase wrote above “a bit more attractive to investors now after the 30% drop of the DJIA”. I’m sorry, this sounds like “now that my friend rebuilt his home after Sandy destroyed it, he’s buying flood insurance.” It would seem if one were going to lock in some value, it should be after a run up, not after a crash.

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