Chris HopkinsFew topics stir the pot more than a critique of variable annuities. Caveat editor.
All too often, financial advisors must deal with the fallout from bad advice offered by a purveyor of variable annuities. Having seen another example in our office this week, we thought a refresher course was in order.
Annuities are as old as the Roman Empire, when investors deposited funds into a pool and received in return a promised annual stipend or “annua.” This type of arrangement involving a promised constant series of annual payments is called a fixed annuity, and remains a valuable and useful tool for creating a dependable income stream.
Variable annuities, on the other hand, are a relatively recent development, dating back to the early 1950s. These products mingled the concept of an income stream in later years with an at-risk investment vehicle like a mutual fund prior to the onset of the fixed payments. Although seldom optimal and often costly in their modern incarnation, there is nothing inherently wrong with the concept of a variable annuity. The problem with some of these products arises from their cost, complexity, and promotion to people for whom they are clearly inappropriate.
According to the Investment Company Institute, 22 percent of households hold IRA accounts that contain variable annuities, yet there are few cases in which this product is appropriate for a tax-deferred account. The primary benefit of a variable annuity is the tax shelter of the investments. Since this already exists inside the IRA, the proximate justification for the product disappears. Consultant Daniel Solin likens it to wearing a raincoat indoors. It is seldom the right choice for an IRA.