Putting Your Money in Variable Annuities

Financial services companies and the brokers who love them just can't get enough of variable annuities. In the days when stocks were hot, VAs were pitched as the ideal way to capture the upside of equities while deferring taxes. Now that Wall Street has become a dirty word, VAs are instead being sold as a no-lose proposition in which you're protected when stocks fall.

Both descriptions are accurate, though incomplete. They conveniently fail to emphasize the disadvantages embedded in the hybrid insurance-investment product. Chief among them are high fees, punishing withdrawal penalties, gimmicky--and pricey--options and enough complexity to stump your accountant.

That doesn't mean there isn't a place for VAs in your portfolio, however, especially with companies continually devising new variations. Specifically, VAs are worth considering for people who have already stuffed every penny possible into 401(k)s, SEPs, SIMPLEs, Keoghs, IRAs or other tax-deferred plans.

Annuities are intended to create a stream of income policyholders can never outlive. You give an insurance company money in a lump sum or in payments over a period of years, then at retirement, the cash gets "annuitized," or paid out in a string of payments based on your life expectancy. Between the time you pay the insurer and the insurance company begins paying you, the cash sits in the account tax-deferred.

Unlike fixed annuities, VAs provide an opportunity to invest contributions in mutual fund subaccounts during the intervening years. In addition to multiple fund selections, VAs come with dozens of bells and whistles on the account structure itself, including a typical one guaranteeing your heirs will receive at least as much as you paid in should you die early. Each bell and whistle, though, comes at a price.

Two new variations on the VA are worth a look. One provides a guarantee that the account value won't fall even while you're alive. The other ties the account's rise to a specific stock index, but promises your holdings will stay unchanged if the index falls. Either option will cost roughly 0.75 percentage points in extra fees.

The biggest caveat to buying VAs is they are frequently sold by insurance agents, bank salespeople or others who don't understand or won't explain the fees and drawbacks well. New SEC requirements obligating insurers to spell out the confusing fee structures beginning this year will help, but when it comes to VAs, the message remains "buyer beware."

Scott Bernard Nelson is a financial writer at The Boston Globe.