CFOs To Go

Two For One

Financial pundits constantly urge consumers to invest now to maintain a good lifestyle during their retirement years. For some, that means investing in variable annuities.

"Variable annuities are commonly referred to as a mutual fund inside a tax-deferred insurance wrapper," says Patrick Reinkemeyer, editor of the Morningstar Variable Annuities/Life newsletter.

Variable annuities have two basic components, he explains. The investment component lets you invest in stocks and bonds through mutual funds. The second part, an insurance policy, guarantees a steady income for a pre-selected time. Variable annuities differ from mutual funds in many ways.

Variable annuities are usually more expensive, says Reinkemeyer. For mutual funds, the average expense ratio is 1.4 percent of assets; for variable annuities, it's 2.13 percent.

"However, in variable annuities, money accumulates tax-deferred," says Reinkemeyer, adding that typically, mutual funds are not truly tax-deferred unless housed in a retirement vehicle such as an IRA or 401(k). "Every year, I pay [capital gains] taxes on any securities bought and sold within the mutual fund."

In contrast, securities can be freely bought and sold within a variable annuity. "Mutual funds don't annuitize," says Reinkemeyer. "When you take money out of a mutual fund, you pay taxes on it because it's being sold."

Tony Sagami of ProFutures Financial Group, an annuity distribution firm in Austin, Texas, offers another caveat. "[When distributed,] variable annuities convert capital gains into ordinary income, which is taxed at a top rate of 39.1 percent compared to 20 percent for a top mutual fund's [capital gains] rate," he says. "So when you take money out of variable annuities, you'll pay more in taxes."

Reinkemeyer says the best candidates for variable annuities are people who've maxed out their annual IRA and 401(k) contributions and are willing to invest for eight to 10 years. Be prepared to ante up at least $2,500, and be aware you'll be charged if you cash in an annuity before age 591|2.

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This article was originally published in the November 1997 print edition of Entrepreneur with the headline: CFOs To Go.

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