Five Reasons Not to Buy a Variable Annuity

While navigating around the investment world, you may have bumped into a common sales pitch – a pitch to buy a variable annuity. Investors can’t help but be exposed to the variable annuity sales pitch when shopping around with various financial advisors. Once considered the “hot” new investment tool, the variable annuity has fallen into disfavor with some investors because of aggressive sales tactics and reports of advisors selling unsuitable variable annuities to vulnerable senior citizens. If this isn’t enough to turn you away from this somewhat over-hyped investment, perhaps these five reasons will help you make up your mind.

1. Fees
Variable annuities often charge exorbitant fees. According to Morningstar, an investment information site, the average annual fees on a variable annuity are about 2.14% of assets. Compare that to other lower-fee investment vehicles, such as efficient mutual funds, and even other types of annuities, and variable annuity holders clearly come out as losers on the fee side of the equation.

2. Surrender Fees and the Early Withdrawal Penalty
Like most other types of retirement savings, you would be charged a 10% IRS tax penalty if you remove money from your account before age 59 ½. However, unlike most other retirement savings, you may also be hit with hefty early withdrawal fees, imposed by the insurance company, if you try and take money from the annuity before the surrender period is up. The surrender fee does get smaller as time goes by, and eventually is eliminated, but that doesn’t help you when you need access to your funds in the second year of the contract?

3. Taxes
Granted, an annuity’s tax-deferred status is a great bonus for anybody looking to have their money grow tax deferred, but there does come a time when you have to pay those taxes. A variable annuity’s tax-deferred status does not help you if you are in a higher tax bracket upon annuity withdrawal – higher taxes eat up the annuity’s compounding advantages.

4. The Death Benefit
At first glance, the death benefit seems to be a good reason to buy a variable annuity. But consider this – according to Limra International, an insurance industry research group, only 1% of annuity holders passed away, necessitating the use of the death benefit – not exactly an oft-used benefit. If you are worried about taking care of your loved ones after you die, you would generally be better off buying a comprehensive life insurance policy where death benefits flow tax-free to your beneficiaries.

5. The Risk
Unlike other annuity products, the funds in your variable annuity are not guaranteed. That means you run the risk of losing your principal and any credited gains.