Introduction to Variable Annuities

By:      Michael D. Handelsman
Sallah Astarita & Cox, LLC
Variable annuities offer investors the opportunity to participate in the stock
market while providing the protection of an insurance product. Variable
annuities offer investors a menu of investment choices, usually mutual funds.
The value of the annuity is directly affected by the performance of the
investment choices made inside the annuity. Eventually, investors in a variable
annuity receive a stream of payments over time or a lump sum payment.
Prior to investing in a variable annuity it is important for potential
investors to receive and review the prospectus for the product. The prospectus
contains important information regarding the risks associated with the annuity
and the features of the product. Upon receipt and review of the prospectus an
investor should ask their financial professional any questions they may have
about the product.
Too often,
investors ignore the prospectus, only to find out years later that there was
language contained therein that would have given them pause prior to their
investment. Further, during a later dispute regarding the product, if a
prospectus was received by an investor, it will be presumed that the investor
was aware of the contents of same. Take the time and read the prospectus and
other offering documents.
It is important to note that variable annuities are not appropriate for
short-term investors. They are designed as long-term retirement savings
products. Investors may be charged penalties or taxes as a result of early
withdrawals. Therefore, variable annuities are not a good choice for short-term
In addition, considering that variable annuities are not suitable as short-term
investments, variable annuities are also not appropriate for all investors. For
example, an annuity is less likely to be suitable for an investor at an
advanced age or an investor who will need access to the funds in the near
future for big purchases such as a house, or paying for college for a child or
children. It is important to consider how a potential investment in an annuity
fits with an investor’s overall financial plan.
As with all investment products, variable annuities are not guaranteed to
result in profit. Since a variable annuity invests in underlying mutual funds,
the risk present when investing in variable annuities is similar to that of
traditional investing in mutual funds or the stock market.
That being said, there are important differences between investing in a
variable annuity and a mutual fund. Unlike mutual funds, variable annuities
offer individuals the ability to receive a stream of periodic payments for the
rest of their life, or the life of a spouse.
Many variable annuities offer a death benefit. If an annuity owner dies prior
to receiving payments, a named beneficiary will receive a specified payment.
Often the inclusion of a death benefit will result in higher costs of ownership
of the product.
The owner of the annuity will not pay any taxes on any income or investment
gains created by the underlying investment choices made in the annuity.
However, when the money is taken out, the earnings will be taxed as ordinary
income, as opposed to at the capital gains rate, and a 10% tax penalty will be
applied if money is withdrawn prior to the annuitant reaching the age of 59.5.
It should also be noted that there is no extra tax advantage if you are putting
a variable annuity in a tax advantaged account such as an IRA or 401(k).
It is important that your financial professional explain all fees and charges
associated with the proposed variable annuity. Often, withdrawals made during
the first few years that an individual owns a variable annuity will result in
“Surrender Charges.” Also, different investment options offered by
the annuity may result in different expenses and charges. There are countless
features that can be added to a variable annuity. However, in most cases there
will be additional charges associated with these features.
The Financial Industry Regulatory Authority (FINRA), a regulator of the
securities industries, has issued guidance to financial professionals to help
protect the investing public from being placed in unsuitable variable
annuities. According to FINRA, the myriad features available with variable
annuities make the suitability analysis particularly complex.
Prior to recommending that their client invest in a variable annuity it is
important for the firm/financial professional to gather comprehensive
information about their customers including their age, number of dependents,
investment objectives, risk tolerance, tax status, net worth, and annual
Financial professionals should also have a thorough knowledge of the
specifications of each variable annuity recommended and discuss expenses, fees,
and liquidity issues with their client. Furthermore, as mentioned above,
financial professionals should only recommend variable annuities to those individuals
who have a long-term investment
FINRA also recommends that firms establish special procedures to insure that
their financial professionals are not recommending variable annuities to
individuals whose age makes this long-term investment inappropriate. Depending
on the clients’ age, any investment in a variable annuity may be unsuitable.
Variable annuities are highly complex financial products that offer an almost
limitless number of features and options. The nature of variable annuities
makes the suitability analysis performed by financial professionals and firms
highly complex. It is important for firms and financial professionals to only
recommend variable annuities that are suitable for their clients.
If you would like to discuss the suitability of your variable annuity
investment, please contact Sallah Astarita & Cox, LLC at 212-509-6544.

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