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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
A variable annuity in an IRA?
Dear Dr. Don,
I was forced into early retirement by
layoff in November. It was recommended that my 401(k) be rolled
over into a variable annuity (Designer IRA).
I'm concerned whether this was the best thing to do
to avoid losing my hard-earned money after all these years. My husband
will be retiring Jan. 31, and I believe he will be advised to do
the same thing. Please advise us ASAP. We are not wealthy, but want
to be safe.
Thank you for advice,
Gloria Gelt
Dear Gloria,
Let's start out by stating that money invested in a variable
annuity is pretty secure, so you don't have to lose sleep over that.
Whether or not you should be invested in a variable annuity within
your IRA rollover account is another matter.
Variable annuities are so seldom the right choice
for an IRA account that I'll go out on a very short limb and tell
you that your husband shouldn't do it and you shouldn't have done
it.
You probably won't be able to undo your transaction,
so it may be in your best interest to keep the money in the variable
annuity, at least until the surrender charges fall off. Surrender
charges in variable annuities can be pretty steep in the first years
before declining to zero, usually in five to eight years.
Variable annuities are tax-deferred investments, but
so are IRA accounts, so you don't need a variable annuity to defer
taxes within your IRA account. Variable annuities also provide an
insurance component that guarantees that you won't lose principal
regardless of investment performance if you die before starting
to receive income from the annuity.
Most IRA investors would be better off not having
the insurance component because what they pay for insurance is likely
to exceed any losses they might experience in their portfolio over
time.
The insurance component is priced into the variable
annuity's mortality and expense risk charge. The average mortality
and expense risk charge on a variable annuity is about 1.28 percent.
So, in five years you've paid 6.40 percent. Could you lose more
than 6.40 percent over that period? Yes, but the longer the holding
period, the less likely it is that the mortality and expense risk
charge works in your favor.
Just like mutual funds, variable annuity sub-accounts
pay for investment management. The average management fee for a
variable annuity sub-account is about .77 percent. What this means
is that between the investment management fees and the mortality
and expense risk charges, the average variable annuity investor
is paying about 2 percent of her account's value in expenses. That
drag on return will hold back the account's performance.
So, it's not that the money isn't safe, since the
insurance component is protecting you from losses. It's that you
could be doing better by investing in mutual funds through an IRA
rollover account.
For example, you can invest in the Fidelity Spartan
US Equity Index (FUSEX) fund with an annual expense ratio of just
.17 percent and the Vanguard Total Bond Index (VBMFX) fund with
an annual expense ratio of just .22 percent. Both are no-load funds.
Editor's Note:
Dr. Don holds a position in the Fidelity Spartan US Equity Index
fund.
-- Posted: Feb. 7, 2002
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