As a finance professor, I meet and work with well-educated investors every day. When discussing their investments, I often find that these investors not only understand variable annuities, but own them in their own investment portfolios.
When asked why they invested in variable annuities, they usually give several reasons, including the following:
1. Commission-free Investing
Unlike most mutual fund and stock investments, when variable annuities are purchased, no up-front, out-of-pocket commission is charged to the investor. A declining contingent deferred sales charge is imposed if the variable annuity is not held for an agreed holding period that averages six years. Long-term investors are rarely concerned about contingent deferred sales charges (CDSC) because they hold their variable annuities for the agreed holding period, thus avoiding these charges. Purchasers of variable annuities, depending on their needs, can select variable annuities with holding periods ranging from zero to 10 years. Typical mutual funds and stocks require investors to pay up-front, out-of-pocket commissions. Knowledgeable long-term investors realize that investing without having to incur commissions will increase their investment gains over time.
2. Low Annual Cost of Investing
The annual cost of owning the average, actively managed equity based variable annuity, whether in a taxable account or retirement account (i.e., IRA, 401(k), etc.), is less than the annual cost of owning the average, actively managed equity mutual fund. An actively traded stock portfolio can generate commissions and taxes that can exceed the annual cost of owning the typical equity-based variable annuity.
3. Tax-Deferred Investing
Variable annuities grow tax-deferred. This not only simplifies owning variable annuities but eliminates the payment of income taxes that some investments, like mutual funds, generate annually regardless of whether the funds increase or decrease in value. Successful and knowledgeable investors understand the importance of tax-deferral. John D. Rockefeller once said, "The surest way to accumulate wealth is to make sure you never pay taxes on income you don't use." Because variable annuities grow tax-deferred, income taxes are not paid until withdrawals are made from these annuities. Tax conscious investors realize that by avoiding taxes today, their variable annuity will grow to a larger amount than taxable investments and may be subject to lower income taxes after retirement. A LIMRA study conducted in 2003 found that 67 percent of affluent households cited income tax considerations as the leading reason for contacting financial professionals.
4. No-Cost/Tax-Free Trading
Variable annuity owners may trade among the different fund families in their variable annuity without paying commissions. In addition, these trades do not result in taxable transactions. Changing investments among different mutual fund companies or buying and selling stocks may involve either an additional commission or the triggering of an income tax liability or both.
5. No-Cost Asset Rebalancing
Nearly every variable annuity issuer today will, without cost, automatically rebalance a variable annuity owner's investments on a periodic basis. Even if automatic rebalancing is not provided, variable annuity owners are free to rebalance their investments without cost and without triggering an income tax liability. Cost-free rebalancing is not generally available with mutual funds and stock accounts. Where such rebalancing is accomplished by a mutual fund or stock owner, such changes often result in the imposition of additional commissions or taxes or both.
