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Variable Annuities – Uses and Abuses: Part 2

By Eve Kaplan CFP®

Last month we fired an opening shot at Variable Annuities to highlight their uses and abuses. We’ll continue this discussion this month by looking at them in greater detail.

To summarize, I mentioned last month why so many annuities get sold (very profitable, for one) and why so many people buy them without understanding them well. Annuitants (annuity holders) I meet never seem to know they’re getting their hands tied to an expensive investment that unnecessarily restricts their freedom of choice and doesn’t protect them as much from the market as they think.
Variable annuities just aren’t the “quick fix” for retirement some annuitants think they are.

Let’s review in detail some of the pros and cons re: variable annuities:

1. Any annuity takes taxable income and converts it to tax-deferred income (note: this is redundant if the IRA is put into an annuity). This is good if you’re in a high tax bracket now, don’t need the money now and expect a lower tax bracket when you draw your annuity.

2. Some variable annuities (expensive ones with bells and whistles) provide downside protection in stock markets. This certainly was helpful this past year. However, the underlying expenses are quite high for this type of “portfolio insurance” (and a lot steeper than they used to be since September 2008). Insurers got burned by the market collapse that began last September, so the protection is less generous and/or costs have risen for protection.


1. Converting money to a tax-deferred status means you lose the ability to make use of a loss by offsetting it against gains in your taxable portfolio. Further, you lose the right to deduct an additional 3K/year of excess losses each year.   If you’re in a 33% tax bracket, that’s like losing an extra 1K per year.

2.  The present value of the annuity (a stream of payments for the rest of your life) is higher if you live longer. But variable annuities invest in unpredictable things (stock markets) so the stream of income is unpredictable, too (unless you previously bought the ‘bells and whistles’ annuity). The annuity may have no value if you pass away unless you purchase additional features that pass initial investments to your estate.

3. Locking up money in any annuity means you can’t readily tap the funds if you suddenly need your funds in a hurry.

4. Variable annuities can confine you to an unattractive, expensive investment selection. You’d lost the freedom to roam widely and find the best and most cost-effective investments.

5. School teachers are thrown to the wolves in many 403b plans – these annuities confusingly are billed as “tax-sheltered” investments (giving the impression tax is avoided altogether).

6. One of the worst offenses is putting IRA (already tax-deferred money) into an annuity. Putting IRA into an annuity can be likened to putting a refrigerator inside another refrigerator.

As you can see, the “cons” outweigh the “pros.”

I use annuities sparingly through a network of annuity providers I trust. I prefer fixed annuities – especially inflation-protected annuities that retain purchasing power. And charitable annuities (typically fixed) bestow tremendous tax benefits, secure some income for life and allow the annuitant to gift the balance to a charity of choice.

Financial planning should encompass all aspects of a person’s financial world: insurance, estate planning, education planning (if relevant), investments and tax planning. When done right -without the intrusion of product sales compensating the planner – clients have powerful plans to the end of their lives. The alternative is a quick fix annuity sale by an advisor or broker who usually bypasses a detailed, in-depth analysis of the person’s financial needs.

Again – the expression Caveat Emptor (“buyer beware”) is a good adage when you purchase anything —including a variable annuity.

Copyright © 2009 by Eve Kaplan

Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner. Kaplan Financial Advisors, LLC is a Registered Investment Advisor in NY and NJ. She can be reached at 908-898-0549 or