Why Variable Annuities Stink

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By Clark Howard April 29, 2015

This article appears at the following website: clarkhoward.com

Considering a variable annuity? You might want to think again. Research shows that it takes $100,000 in a variable annuity to generate the same income as $60,000 in an immediate payout annuity.

A look at variable annuities

Let's take one step back — what exactly is a variable annuity? If you ask those who own them or want to buy them, they have no idea! I describe a variable annuity as a contract with the insurance company that masquerades as an investment with insurance wrapped around it.

Variable annuities come with huge sales commissions, huge expenses and a huge tax burden to you. And if you want out, you usually have to pay a massive fee known as a surrender charge.

Variable annuities are sold by insurance salespeople as "can't lose" investments. But often they'll be called by names other than variable annuity. You may hear them referred to as 'income protection plan,' or 'income security plan' or 'life security.' Anything other than using the term annuity, because it's become such a damaged and discredited name.

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Why do variable annuities stink?

Right now, the 15 largest insurance sellers of variable annuities are being asked to reveal the expensive perks they offer to salespeople who meet quotas for pushing this junk. Those perks include free cars, vacations, jewelry, cash, etc.

But there's a more immediate reason why variable annuities stink, and it has to do with the numbers. Syndicated financial writer Scott Burns once took an in-depth look at variable annuities. Burns' analysis contrasted variable annuities with index funds. Remember, index funds are usually sold commission free. No surprise then that index funds blow away variable annuities over 80 percent of the time.

And the coup de grace was when Burns stacked variable annuities up against life annuities (aka immediate payout annuities). Insurance people hate to sell life annuities because they don't have big commissions. But as stated earlier, it takes $100,000 in a variable annuity to generate the same income for you as $60,000 in an immediate payout annuity. See Burns' article for an explanation of how he arrived at that calculation.

So when you're pitched on a 'can't lose' variable annuity, remember Burns' research.

Why immediate annuities are a better option

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When you retire, you may not have enough money to provide for your monthly needs from savings. So there are companies that turn a supply of money into a lifetime stream of income. Immediate payout annuities are entirely legitimate, but they have so little in the way of commissions that they're never pushed by salespeople.

Read more about annuity commissions

One knock that I often hear is, what if you pour all your money into an immediate payout annuity and then you die next week? It's true that all the money will be gone and there will be none for your heirs.

That's why you can opt for a special provision called "period certain," which means that you'll get a guaranteed payout (typically for 20 years) even in the event of your death. Your monthly benefit will drop by about 10 percent if you take the period certain option, but at least it provides something guaranteed to your heirs.

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