The most complex of investment products on the market are variable annuity funds.  And with complexity comes opportunity…to the annuity seller. 

Buyer beware of variable annuity agents (and FYI, they can be dressed in your personal advisor’s clothes).

My favorite and very over-blogged saying is “go to every big city and look up – the tallest building is an insurance building.”

Why do you think that is?

Because insurance companies are offering a low-cost, high-value investment product?  Not exactly.  Perhaps it’s because their margins on their products are so high that they have to buy the largest buildings to house more and more salespeople and plenty of super printers to print out the 115+ page annuity prospectus’ for all clients to pretend to read and understand.

Rant DONE.

The bottom line is this: Owning a variable annuity will, most certainly, and undeniably from insurance industry proponents, cost you more money.

This, for most, ultimately means retiring later. 

Let’s examine the two areas that will result in variable annuities costing you more:  Investment cost and tax cost.

Investment Cost

From an investment cost standpoint, you can expect to pay as much as 3% per year to own a variable annuity product.

How does this compare?

Alphavest’s generous standards to the general investing public suggest that all portfolio fees remain under 1.3% per year.  That’s 1.3% ALL IN.  Professional management, cost of investments, and transaction costs.

Go to Vanguard and manage you portfolio yourself and you can be all in for well under 1%.

What’s important here is that if you pay .8% too much for your investment portfolio, we’ll use 2.1% (in this case, 1.3% + .8% = 2.1%), your overpayment in fees and expenses, over a 25-30 investing lifetime will result in an approximate 21% reduction in your overall retirement nest egg.

Some quick math: A $100,000 invested at 7% over 30 years with fees and expenses of 1.3% would grow to approximately $500,000.  Invested in a higher fee portfolio, say that of a variable annuity, with only .8% more in fees, per year (likely much more), the same portfolio grows to only $400,000.

This is a 20% difference in your retirement nest egg.

Why pay more? Most variable annuity agents will sell you on the fear of volatile markets.

Afraid of losing $100,000? That’s what happened in the above example – WITHOUT the help of a down market.  Take your chances – educate yourself and tell yourself that you KNOW you will lose 20%+ with an annuity.

With the markets, well, invest with a solid and disciplined investment approach that is flush with cash when you near time to begin withdrawals and that’s the horse I’d bet on.  Even if you invested in all cash 5-7 years before your withdrawals begin, you’d most likely come out on top WITHOUT an annuity.

Don’t help build the tallest building. Build your retirement nest egg instead.

Tax Cost

If you invest outside of an annuity and you hold an investment within your portfolio for at least 12 months before you sell it, you’ll pay from 0-15% long-term capital gains on any investment gain on that investment.

In an annuity, however, you will pay ORDINARY income tax rates on every penny you withdraw from the account – not when you sell within the account, but when you withdraw funds.

So while the example is hard to present apples-to-apples, you need to understand that it’s typical that 1/3, or 33%, of every withdrawal from an annuity goes to Uncle Sam.

ONE THIRD.

How?  (CPAs pardon the oversimplification here….) If you’re on your own, and will have a total income of least $37,000 per year, and live in a state with a 6% (21 of all states are at 6% or higher) state income tax, then you will indeed pay 31%+ taxes (federal = approx. 25% + 6% state=31%) on your withdrawals.

On the other hand, if you have 50% “turnover” (selling of one-half of your portfolio each year due to markets and active investment management with that $100,000 example above), this would result in approximately $41k in taxes over 30 years, at the highest of long-term capital gains rates of 15%, versus 31% tax hit on the total accumulation value,  which results in taxes of about $160k.

Which would you rather pay?  In summary, from our example herein:
NON-Annuity:              Annuity
$100,000 grows to:       $500,000                    OR        $400,000
Investment Return:       7%                                           7%
Fees:                              > 1.3%                                     2-3%
Taxes:                            $0-41,000                                $160,000

Don’t let the superb sales (fear) tactics of an annuity agent get the best of you.  Take a step back, say ‘thank you’ and keep your nest egg in tact.