The reasons I never recommend VAs:

Mortality/Death Benefit charges

Since VAs are investment products within an insurance wrapper, every buyer must pay the insurance company a "Mortality and Expense" (usually called M&E) charge each and every year they own the VA. This is usually well over 1%. This guarantees that your account should have a certain value should you die before the annuity payments begin. This may have come true if you bought a VA contract in early 2000, loaded it up with tech mutual funds and then died shortly thereafter. Your beneficiary may have collected your initial VA purchase amount. But the longer you are invested in equity mutual funds the less likely it becomes that your account will be worth less than your original purchase. There has never been a 10 year stretch that equities lost money! After a while you keep paying over 1% for nothing.

Administrative and Annual Fee charges

But the costs do not stop there. There are usually an Administrative fee and perhaps an Annual Fee too! The average administrative fee is about 0.10% and the annual fees could be around $30 or $40 for each VA.

Investment Management Fees

And then there are the expenses for Investment Management of the investments (usually high cost mutual funds) the VA owner invests in. Those are often well over 1% and it is almost impossible to find low cost index funds available in the specific lineup of the VA provider. Which leads to another point: you can be severely limited on what specific investments you can choose within VA contracts; if you invest in regular taxable accounts with a discount broker, your flexibility is almost unlimited.

When you add up all the annual fees, it is very typical for a VA owner to be paying over 2.50% EVERY year for the privilege of owning these products!

Ordinary vs. Capital Gains Taxes

Another major disadvantage of VAs is when you withdraw money from them in retirement you pay ordinary income taxes (which can be as high as 35%) on your gains instead of the much lower dividend and capital gains taxes (no more than 15%) if you had simply invested in a regular taxable account. Yes, you may pay some taxes currently on your dividends and possible capital gains but those taxes can be greatly controlled if you limit your trading and you invest in the proper Exchange Traded Funds (ETFs) or index funds.

Also please remember that if you withdraw from VAs before age 59 and a half you need to pay ordinary income taxes on your gains PLUS a 10% penalty.

Surrender Penalties

If you change your mind and want to get out of a VA you usually must pay a stiff penalty (on top of regular income taxes and a 10% penalty if you are under 59 and a half years old). This penalty usually starts at around 7% and goes down gradually by 1% each year. So, in a way you feel locked up until the penalty period is over.

Estate Planning

VAs and Estate Planning should never be mentioned together. If you die with a VA, your heirs will inherit the income taxes due. If you die with regular taxable investments, your heirs inherit their value as of the date of your death (the famous "step-up in basis").

Real Life example

My most recent client came to me from a large brokerage company holding three VAs. The M&E charges ranged from 1.25% to 2.10%, administrative fees ranged from 0.10% to 0.15% and Annual Fees were $30 for two of the three VAs. Investment Management Fees ranged from as low as 0.60% to well over 1%. Total annual fees for the most expensive VA were 2.65%! It is awfully tough to get ahead when you start out with such a large handicap, especially considering that you can invest outside a VA with Investment Management Fees costing no more than 0.20%. Even if you add the fees charged by a Fee Only financial planner investors usually can dramatically lower their total investment costs!

Let's look more closely in this example. Of the three VAs my client came to me with, two of them (representing almost 50% of their investment portfolio) were inside IRAs! I find this practice highly unethical since there is no justification for placing clients' money in VAs inside IRAs which are tax-deferred vehicles to begin with! To add injury to the insult, the clients' portfolio was almost entirely invested in Large Cap stocks with almost no exposure to International or Small Cap stocks ever since the late 90s. Understandably, the client was still trying to make up the ground they lost after the tech stock bubble burst. Of course no tax advice or proactive phone calls to the clients took place until they finally had enough and looked for an objective and service oriented alternative.

Links for Reference

A few links below for reference:

An article by a law firm titled "Variable Annuities: A Trap for Most"

A Primer on VAs from the SEC

Annuity Truth:
Focuses on VAs being sold to seniors

Immediateannuities.com
A good website to get quotes on fixed annuities which are a completely different product than VAs and could be appropriate for a portion of retirement income for very conservative investors. It can be used to evaluate whether a lump sum paid in a form of monthly annuity for life given in a buyout (such as the recent ones by Ford Motor Company) are a good deal or not.

1035 Exchanges

If you do have a high cost VA you should look into biting the bullet and surrendering it or doing a tax free exchange (called a "1035 exchange") to the VA offered by Vanguard. Vanguard offers a VA with an annual Mortality and Expense (M&E) of 0.20%, an annual Administrative fee of 0.10% and 15 investment options with Investment Management fees ranging from 0.14% to 0.42%.

In Closing

It has been my experience that buyers of VAs are not told of all expenses associated with them and they sign many papers without having adequate time to examine them closely. Frequently, I hear the "but he was such a nice man, I just trusted him/her" excuse. When buyers of VAs realize that they may have been misled it is too late since the excuse of the company behind the VA is usually "but you signed the contract, all the costs are fully disclosed in it"….Never mind that those details are buried in the middle of page 87 of the thick VA booklet.

So, if you or your clients are ever pitched a VA I plead with you to READ the entire contract to know what you are exactly getting into. As one of the top Regulators of the Office of Financial and Insurance Services of the State of Michigan said in a Compliance conference recently "You pay dearly for every guarantee in these annuity products".

• Quoted in the Investment News March 26 2007 issue in an article titled "CFP Board could meet resistance"


The article was regarding the latest proposed changes to the ethical standards proposed by the CFP Board. My views are positive on this development since I always supported the position that all CFP certificants should be fiduciaries at all times.

You can read the artilcle by clicking here.