When Congress turns to raising taxes, American investors turn to variable annuities.
The Tax Reform Act of 1986 that eliminated so many tax-saving opportunities provided the initial stimulus. Last year's reform that boosted the top marginal tax rate gave yet another push.
As a result, variable annuities total more than $220 billion in assets, up substantially from a year ago, and momentum is going strong.
For those of you who haven't yet caught the fever, a variable annuity is a product offered by insurance companies, brokerage firms and banks that permits you to invest in a wide range of mutual funds and to defer accumulated earnings until you begin to withdraw money. That's likely to be when you're retired and in a lower tax bracket.
"Today's consumer is looking at a period of low rates and an
environment in which people feel they can depend less on Social Security and have less job security," said Robert Fiondella, chairman and chief executive of Phoenix Home Life Mutual Insurance.
"They also realize the historical return on equities is 4 percent higher than fixed-rate choices, so as they increasingly focus on returns, the variable annuity looks good."
Annuities are contracts with an insurance company. However, because the policyholder makes the decision on selecting the proper variable annuity fund, or "subaccount," as it's called in the industry, how well your investment does depends on how wisely you invest.
So, if you can't stomach the vagaries of the markets, don't choose a variable annuity. The fixed accounts within variable annuities that offer a guaranteed rate for one to three years won't make sense either, because their average rate is only about 4.5 percent. You'll still have to face the drain from the average annual contract charge of 1.25 percent, plus annual fund expenses, which can bring costs to about 2 percent a year.
Due to all the costs, it's best to be in at least the 28 percent bracket for a variable annuity to be worthwhile.
"Our philosophy would be to maximize contributions to your company 401(K) plan and your individual retirement account first, but, over and above that, focus on variable annuities," said Richard Jameison, president of Fidelity Investments Life Insurance Co.
"The deferral aspect is obviously an advantage, though keep in mind that it's not a tax dodge, for eventually you'll be taxed on it."
Besides tax consequences for early withdrawal, there's generally surrender charge if you cancel your annuity within a certain time. The charge typically starts out at 8 percent and declines each year until it reaches zero.
"The variable annuity is growing in popularity because it's an ideal packaged retirement product with investment options, the ability to make regular deposits and an 800 number in the case of most companies," said Thomas West, senior vice president of Aetna Life Insurance and Annuity Co.
"The buyer varies considerably, with the bank CD rollover buyer usually 50 and older and more conservative, while the customer going through a broker is in their 40s and much more receptive to equities."
With so many choices, shop to find the best deals.
"These days there are basically two kinds of variable annuities -- those with a few solid choices and those with a whole spectrum of choices," said Jennifer Strickland, editor of the variable annuity and life insurance publications of the Morningstar Inc. investment advisory. "Variable annuities have a big role, but they'll never be as big as conventional mutual funds."
Among the best-performing variable annuities, according to Morningstar, are those of Aetna Life Insurance and Annuity Co., Hartford, Conn., whose Account B Variable Fund emphasizing growth and income has a three-year average annual return of 11.51 percent. It hasn't had a negative return in 10 years.
The Best of America IV/Nationwide variable annuities from Nationwide Life Insurance Co., Columbus, Ohio, have provided good returns using portfolios run by outside managers.
One subaccount holding the Fidelity Growth portfolio has a three-year average return of 22.22 percent, while one investing in the balanced Fidelity Asset Manager has a three-year annual return of 16.86 percent. Another, with growth portfolio Strong Special II, initiated a year and a half ago, has a one-year return of 23.54 percent.
From Fidelity Investment Life Insurance Co., Boston, two Fidelity Retirement Reserves variable annuities offering the same Fidelity Asset Manager and Fidelity Growth portfolios as Best of America IV have three-year returns of 17.22 percent and 22.59 percent, respectively.
The Phoenix Home Life Big Edge Plus Growth Portfolio from Phoenix Home Life Mutual Insurance Co., Enfield, Conn., had a three-year average return of 22 percent.
The Franklin Valuemark II variable annuities from Allianz Life Insurance of North America, Malvern, Pa., offers an Income Securities balanced portfolio with a 21.70 percent three-year return.