A variable annuity is a contract with an insurance company. In return for the purchase of the annuity, either through a upfront payment or scheduled payments, the insurance company agrees to make periodic payments to the purchaser (called the “annuitant”) either immediately or some time in the future. The annuitant has the option to invest their funds in various types of investment vehicles (typically mutual funds). Investment selections can be changed to suit the investor with no penalties or tax consequences.
There are certain benefits to the annuitant regarding the purchase of an annuity. For instance, all capital gains and income from the underlying investments grow tax free until withdrawn (after age 59 1/2). If a death benefit is attached to the annuity, and the annuitant dies unexpectedly, the payments continue to a designated beneficiary. There can also be a guaranteed minimum value to the annuity; the minimum value is guaranteed notwithstanding the market performance of the underlying investments.
HOWEVER, there is a cost to the annuitant to obtain these benefits in the form of increased fees charged to the annuity. Additionally, it is expected that there will be no early withdrawals from the annuity in the first 6 – 12 years after purchase (called the “accumulation phase”). If the annuitant has a sudden need for funds and makes a withdrawal during the accumulation phase, there will be a deferred sales charge (typically beginning at 8 – 12% of the withdrawal, with the percentage decreasing by a set rate each year) and tax penalties if the annuitant is younger than 59 ½ years old.
If an annuity is purchased in a tax-deferred account, such as an IRA, there are no additional tax benefits conferred on the annuitant.
Lastly, the management/administrative fees charged by the insurance company are on top of the fees charged by the underlying funds; therefore, simply buying mutual funds directly is cheaper for the annuitant (but there would be no death benefit, guaranteed minimum value, etc.).
One final note: most objective and knowledgeable people in the securities business would say that, for most investors, a variable annuity should only be purchased after every other tax deferred investment strategy has been exhausted.
All of the above points to the fact that variable annuities are complex investment products. Every potential annuity purchaser should fully explore and understand the characteristics of the annuity he is considering purchasing.
On the other hand, if a person who purchased an annuity in the past now feels he was misled or deceived about his purchase, he should contact the securities arbitration attorneys at Lubiner, Schmidt & Palumbo for a free consultation.