Apparently I’ve ruffled some feathers in my industry because of my disdain for variable annuities. It’s not going to deter me, though. Too many times I’ve created financial plans for clients only to have their plans thwarted because they’re handcuffed to these contracts that were sold to them, probably inappropriately, by someone who maybe didn’t bother to do any research to determine if it was the best option for them. Let me say that annuities do have a place in some financial plans but, like I tell my clients, “Annuities are like rottweilers; they can be good, but not everybody should have one.”
Almost all annuities have a surrender period, typically seven years. If you decide to take your money out or transfer it to another annuity within this surrender period, you may have to give up to 10% of your investment back to the annuity provider. I don’t like this; it ties a hand behind your back and makes you stay with a product for no good reason. Let me say that annuities are intended for retirement, so I’m not encouraging anyone to take their money out for non-retirement purposes. I just like my clients to have options with their own money, and if they’re unhappy with the product or representative, why should they be penalized for choosing to move the money elsewhere?
Variable annuities do not benefit from lower capital gain tax rates; when you take the money out of an annuity, any increase in the account is taxed as ordinary income, and it could potentially increase not only your taxable income and taxes, but may also cause your Social Security payments to be subject to more taxation.
So what can be done with these things? Well, for starters, annuities are supposed to be used for retirement, they can serve as a self-made pension plan. Annuity payments that are actually annuitized – taken over a lifetime – are taxed slightly more favorably (a portion of each payment is a return of your original investment and is non-taxable, and a portion represents gain and is taxable). Statistics show that less than 1% of annuity holders select this option. Why? Because your payments die with you, unless you select some kind of “joint and survivor” option, which will provide payments for both spouse’s lifetimes, but this option lowers your payments.
The second option is relatively new and accommodates the current issue at hand; long-term care. New legislation allows you to exchange an annuity for a long-term care policy and any gain in the annuity is not taxable. This is pretty huge, because most people recognize the risk of potentially needing some form of long-term care (assistance at home, assisted living, nursing home care) and the potential cost of such care (in WNY annual nursing home care hovers around $100,000). The need for long-term care could quickly wipe out a person’s nest egg. Long-term care insurance can be the right solution but, again, it might not be right for everyone. There have been hybrid policies that have come out recently that combine life insurance with long term care benefits; I like this because – either way – you are going to make a claim, which isn’t the case with traditional long-term care insurance.
A third option will resonate with those individuals who are charitably inclined. Variable annuities could be placed into a charitable instrument, such as a charitable remainder trust, and the donor may receive an income from the trust for a period of years and what remains at the end is left to a charity. The donor is provided with a charitable deduction, based on many factors, which can offset taxable gain on the annuity.
These are just some ideas, everyone’s situation will be unique and is best addressed with a team of financial experts including a CERTIFIED FINANCIAL PLANNER TM practitioner, a CPA, an attorney and an insurance specialist. Collaboration among professional advisors promotes a system of checks-and-balances while creating an atmosphere of creativity and innovation.