Variable annuities have become a huge business, holding more
than $1.6 trillion in assets. Many of these annuities include
guaranteed lifetime withdrawal benefits, which promise you'll
receive a minimum amount of income each year for life, no matter
what happens to your original investment.
For most variable annuities with guarantees, you invest a lump
sum in mutual-fund-like accounts within the annuity, and the value
can grow with the investments. Most people buy these annuities in
their fifties and sixties, and they let them grow tax-deferred for
several years before starting to tap the account.
Every year, you pay fees just to preserve the income
guarantees--perhaps $17,000 over ten years for a $100,000 account.
With the newest generation of products, you still have access to
the underlying investment.
But if you make a wrong move when you withdraw the money, you
could forfeit the guarantees. Here's how to avoid variable annuity
Switching to a new annuity.
Guarantees on variable annuities sold in the late 1990s to mid
2000s tend to be much more valuable than guarantees on versions
sold today. Some of the older annuities let you withdraw as much as
6% a year from the highest value the account reaches. After the
market downturn in 2008, insurers began to reduce their risk on new
annuities by boosting fees and lowering annual withdrawals to 5%.
Many of the older annuities work like this: Say you invested
$100,000 in a variable annuity with a 6% annual guaranteed
withdrawal benefit. The market value of your investments rises to
$130,000 but later drops to $80,000. Your guarantee will be
calculated on a $130,000 "guaranteed value" rather than on the
actual "account value." An annual withdrawal of $7,800 for life
would be based on the guaranteed value. Some annuities promise that
the guaranteed base will double if you wait ten years before
withdrawing any money, no matter what happens to the actual
These old annuities can be a great deal, so be wary of any
broker who wants you to switch out to buy a new product. Consider
the source: Salespeople make new commissions when you buy a new
A big downside to switching: In the example above, you would
only get the $80,000 account value from the old annuity, not the
$130,000 guaranteed value. "The guaranteed amounts never transfer
over," says Michael Bartlow, an adviser for financial planning
company VALIC, which sells annuities, in Hickory, N.C. "People need
to take the time to figure out what they're walking away from."
Also, it's unlikely that any annuity you may buy to replace it
will offer a 6% guarantee, and you may have to pay a large
surrender charge if you switch.
Not making the most of the guarantees.
If you're paying from 0.95% to 1.75% a year in fees just for the
guarantee, then you should invest that money more aggressively than
your investments without guarantees. You take a risk with
aggressive investments, such as growth stocks, but you could reap
big gains. Remember, the lifetime guarantee is often based on the
highest value the investments reach. So even if your investments
take a hit for a few years, you'll have a guaranteed floor. And
when the market rebounds, your guaranteed value will rise as
Mark Cortazzo, a certified financial planner in Parsippany,
N.J., who helps advisers and individuals analyze annuities, says
that annuity owners shouldn't waste the guarantee. "If somebody has
$100,000 to $200,000 in an annuity with an income guarantee,
they're spending thousands of dollars a year in protection," he
And annuity owners should coordinate their annuity investment
strategy with their other investments, Cortazzo says. In 2000,
after his first wife died, Bryan Davis invested in a Nationwide
variable annuity that didn't have an income guarantee. After
retiring as a middle-school physical education teacher, Davis moved
from New York to Arizona. He bought a Sun Life annuity in 2010,
which lets him withdraw 5% of the guaranteed value every year.
Neither salesperson asked about his other investments, says Davis,
62. "They just wanted to make money off me," he says.
Davis's current financial adviser asked Cortazzo to analyze the
annuities. Cortazzo concluded that Davis's investments were totally
wrong for the types of annuities he held. The annuity without the
guarantee was invested primarily in stock funds, while most of the
annuity with the guarantee was invested in a balanced fund.
Cortazzo recommended switching the Sun Life annuity into about
70% stocks. He then shifted some money in the Nationwide annuity
from an aggressive small-company stock fund into a fixed account
that pays a minimum of 3% interest. (Cortazzo's firm, MACRO
Consulting Group, will review up to three annuities for $199. Go to
Withdrawing too much money.
The annuities with guarantees generally let you withdraw up to 5%
or 6% of your guaranteed value each year. But taking more money can
reduce the guaranteed value, which will reduce your future
guaranteed payouts--sometimes by a considerable amount.
The result can vary by annuity. Cortazzo offers two hypothetical
examples of how annuities change the guaranteed value if you
withdraw too much. Both annuities have a $500,000 account value and
a $1 million guaranteed value. You can withdraw 6% of the
guaranteed value each year, for a withdrawal of $60,000.
If you withdraw an extra $5,000 just once, one of the annuities
will reduce your guaranteed value to $990,000, and your annual
withdrawal will be $59,400. The other will slice the guaranteed
value to $500,000--and your annual withdrawal will drop to $30,000.
The lesson: Make sure you understand the impact of extra
withdrawals on your guaranteed base.
Choosing the wrong beneficiary.
Cortazzo noticed another problem with Davis's annuities. Davis had
remarried, and he had been paying for a joint-life guarantee that
would continue the Sun Life payouts for as long as he and his wife
lived. But instead of making his wife the beneficiary, the
brokerage firm where he bought the annuity had named his IRA as the
primary beneficiary. His wife could receive the account value after
he died, but the lifetime income would stop. "A spouse who isn't
the primary beneficiary on an annuity can't continue the contract,"
says Cortazzo. Say your guaranteed value is $200,000 and you've
been taking out 5% a year ($10,000), and the account now has just
$40,000 in actual value. If your wife is the beneficiary on a
joint-life annuity, she can receive $10,000 a year for life after
you die. If she isn't the primary beneficiary, she'd only inherit
the $40,000. Davis changed the beneficiary so his wife could
receive the lifetime income.