Utility of variable annuities?
April 17, 2008 11:41 AM   Subscribe

Help me analyze a variable annuity as a tax-deferred retirement savings option.

I'm considering a variable annuity as an additional vehicle for tax-deferred retirement savings, and could use some help with a "first approximation" analysis.

I'm already maxing out 401k and IRA contributions. The annuity I'm specifically considering is Fidelity's Personal Retirement Annuity. This is a variable annuity with a 0.25% annual annuity charge, no surrender charges, no death benefit, no sales charge, and the ability to select from some 30+ mutual funds as the underlying investment instruments.

Let's say I've got a chunk of money I'd like to invest for retirement (so not looking to cash out until then), and to do it via tracking the S&P 500. The two options I'm comparing look something like this:

1) In a variable annuity, invested in the S&P 500 index fund option they offer (Fidelity VIP Index 500).
2) In a normal brokerage account, invested in an S&P 500 ETF.

I'm choosing an ETF for option #2 because I gather it ought to minimize annual exposure to capital gains tax (although dividends will still be taxed). Is this roughly correct?

Seems like what's going on here is that in return for paying 0.25% a year in the annuity, all growth (capital gains and dividends) is tax deferred, so if that 0.25% is less than the amount of annual income tax I'd pay on the dividends coming out of the ETF investment, then I'm ahead. Am I missing something big here?

(I'm concerned that there doesn't seem to be any guarantee that the 0.25% annuity charge won't increase -- if that were to happen, I could see it eventually wiping out the advantage)
posted by kanuck to Work & Money (3 answers total) 1 user marked this as a favorite
I don't know much about variable annuities, but this article which seems to analyze your exact situation might be helpful.
posted by 0xFCAF at 11:54 AM on April 17, 2008

The Fidelity product sounds like it might actually have some value, but one of my rules in life, based on reading Andrew Tobias' The Only Investment Guide You'll Ever Need many years ago, is to avoid anyone who tries to sell me an annuity. It does sound like the Fidelity product is trying to avoid the useless expenses of typical annuity products, however. In any case I think you've got the right analysis. Me personally (at my age, 55), I'm just going to continue to avoid anything called an "annuity."
posted by thomas144 at 12:12 PM on April 17, 2008

Be careful of one time fees too. I've heard with various other similar instruments that the sales commissions are outrageous, and can basically take a whole year or two of growth out of the account.

In addition, you're saving 20 grand a year at least (15.5 + 4), do you really need further retirement savings? Would you be more financially secure if you want to retire early, and need regular cash to tide you over till you can get at the retirement accounts? In that case, the normal ETF route might be better. Not from a pure max-out-dollar-amount stance, but from a what-can-I-do point of view.

Also, the deferred taxes won't buy you much if you are withdrawing from the 401k as well, since it'll all add up to enough in income that you're paying a bunch in taxes anyway.
posted by cschneid at 1:50 PM on April 17, 2008

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