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What You Need to Know About Variable Annuities

Seth Jentner06/27/2013

People continue to place billions of dollars into variable annuities attempting to obtain safety and lifelong incomes. There are plenty of people who fear the market but want an opportunity to invest in the market without the downside risk.

Variable annuities enable customers to save for retirement with investments such as stocks and bonds. Their earnings grow tax-deferred until withdraw, presumably upon retirement.

For the two largest U.S. life insurance companies, MetLife and Prudential, one of the hottest products, variable annuities, offers a guarantee of income for life, even if the customer’s account balance falls because of market declines.

According to an article in Financial Advisor Magazine published in June 2012, this protection comes at a cost, with many conditions and limitations that are difficult for consumers to understand.

For example, the guaranteed income rider cost averages a little over 1% annually on the assets in the annuity. That is in addition to the other annuity fees, which average about 2.5%. These high costs make the upside potential of variable annuities fairly limited. Unfortunately, I have observed that the upside opportunity promised by these annuity companies is generally one of the strongest selling points for those that purchase them.

Keep in mind that along with these guarantees are restrictions on withdrawals. Once the owner of a variable annuity starts to take the guaranteed income out of their annuities, they are unable to withdraw additional funds.

The bottom line:  While lifetime income guarantees on variable annuities offer protection against investment losses, they are complicated and expensive. They may also offer limited protection against future inflation-rate increases.

Investors with an understanding of and a tolerance for temporary market fluctuations may be able to earn better returns with transparent, low-cost, diversified portfolios of index-type mutual fund and asset-class fund investments. If you understand and can accept the inevitable market fluctuations, this will help you achieve adequate returns as you seek financial independence.

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