Newspaper article St Louis Post-Dispatch (MO)

Caution Flag Raised on Annuities

Newspaper article St Louis Post-Dispatch (MO)

Caution Flag Raised on Annuities

Article excerpt

Investors love a tax-deferral, which accounts for the huge popularity of variable annuities. But you may shoot yourself in the foot if you buy them purely from tax-aversion. Because of their high costs, annuities may return less after-tax than you'd get from a comparable mutual fund.

Annuities sound like an easy choice. They're like mutual funds, but because they're a kind of insurance product, all your money grows tax-deferred. Your investment choices typically include stocks, bonds, balanced stock-and-bond portfolios and a fixed-income account.

Annuities are for long-term investors; you normally face an exit charge if you sell within five to seven years. There's also a 10 percent tax penalty on money withdrawn before age 59 1/2. All withdrawals are taxed as ordinary income. So investors get no advantage from lower taxes on capital gains.

Here's a checklist, outlining who should do well with variable annuities (VAs). Buy them only if you can answer all of these questions "yes":

Have you put the maximum amount of money you're allowed into a tax-deferred retirement account? These plans earn you more than a VA will, because you're investing money pretax. Commercial VAs are bought with your earnings after tax.

If your plan permits after-tax contributions, choose those over a VA, too. You'll pay less in annual expense.

Don't put a VA inside your retirement plan, advises Glenn Daily, a life insurance consultant in New York. Retirement plans confer tax-deferral on any investment you put in them, so you might as well choose mutual funds, which carry lower costs.

Will you invest your variable annuity in either stocks or high-yielding (junk) bonds? If not, the VA probably isn't worth it. You need a shot at high long-term returns to overcome the VA's high costs. If you'd rather invest in high-quality bonds or money-market investments, choose mutual funds instead.

Will you start young enough to make the tax-deferral pay? You typically have to hold a VA for 16 years or more, if you buy from a stockbroker or insurance agent and put all your money into stocks. That's how long it takes for the VA to do better than straight, stock-owning mutual funds, according to mutual-fund company T. …

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