Variable annuity may cut risk if issuer goes under

June 16, 1991|By Jerry Morgan | Jerry Morgan,Newsday

With insurance companies such as First Executive and First Capital going under and holders of their annuities unable to get ++ their money out, you might be a little leery if you get a call from a salesperson offering a variable annuity.

But because of the way it is structured, a variable annuity may -- repeat, may -- be safer than a fixed annuity. That does not mean you should rush out and buy one. Variable annuities are as complicated as they sound. But with about $50 billion sold already, someone is buying them.

Briefly, a variable annuity is a contract that allows you to put money in investment funds that are similar to mutual funds and in which the profits are tax-deferred. Usually, there is a death benefit that covers the amount of your investment. The eventual payout can be taken in a lump sum or in monthly payments to provide income in retirement. As with other retirement accounts, withdrawal before age 59 carries a 10 percent penalty.

A variable annuity shifts the investment risk to the policyholder, who chooses among investment funds. That differs from a fixed annuity in which the company is on the hook to pay a certain amount, regardless of how its investment portfolio performs.

Despite that risk, a variable annuity may be safer if the insurer goes under because the investment funds are held in separate accounts and are not general liabilities of the insurance company. Rick Morse, a supervising insurance attorney for the New York State Insurance Department, said that the separate accounts would not be frozen if the insurer is seized by regulators because of insolvency.

Anyone considering a variable annuity should understand they are long-term investments for retirement.

"People misunderstand them and think they are just mutual funds, but they are really long-term investments, and if you just want something for five years or so, these are not it," Rodney Rohda, president of the Fidelity Insurance Investment Co., said.

Because of heavy fees, which can include front-load sales charges, rear-load surrender fees, management fees, death benefit expenses and administrative and paperwork fees, it can take an investment five to 10 years, depending on the fund's performance, to make the tax-deferral benefits outweigh the costs.

"The two most important things to look at are expenses and fees," said Glenn Daily, an insurance consultant and author of a guide to low-cost policies.

According to R. H. Carey, publisher of Variable Annuity Research and Data Service in Miami, which tracks the performance of variable annuities, fees and expenses averaged 2.28 percent in 1990, or about $570 a year on a $25,000 investment.

That is more than double the average for equity mutual funds, according to the Investment Company Institute's 1989 figures.

Some no-load fund managers, such as the Vanguard Group and Scudder, Stevens & Clark, offer policies with fees half the average and with no surrender or withdrawal fees.

But Mr. Carey said that low-cost funds do not necessarily perform as well as more expensive ones just because they have lower fees.

Even those who sell the contracts say that a variable annuity should not be the first thing that comes to mind when deciding how to allocate money for retirement.

"First, take anything that is tax-deductible, like an Individual Retirement Account or a 401(k)," said Jim Smith, vice president for marketing at Scudder, Stevens & Clark in Boston.

A variable annuity, he said, "makes a pretty good retirement vehicle because it is tax-deferred, but tax-deductible is better."

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