Don't rush to buy tax-deferred annuities

STAYING AHEAD

March 01, 1992|By JANE BRYANT QUINN | JANE BRYANT QUINN,1992 Washington Post Writers Group

New York -- Memo to investors who are now being blitzed by insurance agents selling a "last chance" to buy tax-deferred annuities.

Relax.

There may indeed be a "last chance" someday. But it won't be now.

What started the blitz was President Bush's State of the Union message, in which he proposed to end the tax deferral for certain annuities. In general, he'd allow the tax shelter only for people who agreed to keep their annuities for life. He'd also leave pension annuities alone.

But you wouldn't be allowed to chuck money into a tax-deferred annuity for just a few years and then cash out.

Within a few days after the speech, I was deluged with letters and faxes from insurance agents, urging that I advise readers to buy an annuity quick, before it melts.

But now, the Republicans have pretty much dropped the president's idea, after a storm of protest from insurance companies. Any agent still using a "last chance" sales pitch isn't giving you the right story.

There is, however, a lot of merit to the proposal. All too many annuity buyers are so blinded by the tax deferral that they pay no attention to whether the basic investment makes sense. The best way to make an annuity pay is, as the president suggests, to keep it for life.

What is an annuity? It's an investment created by an insurance company and sold by stockbrokers, insurance agents, financial planners and many banks.

"Fixed" annuities pay an interest rate that isn't fixed at all; it changes whenever the insurance company says, which may be often. "Variable" annuities let you invest your money in stocks or bonds and gamble on what the outcome will be.

A "deferred annuity" accumulates money for the future. An "immediate annuity" pays you a lifetime income, starting from the day you buy. (Note that this discussion covers annuities bought with after-tax dollars, not the tax-qualified annuities that are often used for pensions.)

The earnings in any annuity build up untaxed. You normally pay a 10 percent penalty on any funds withdrawn before age 59 1/2 . In most cases, the insurer also levies a penalty if you drop the annuity within five to seven years. Any cash withdrawn is subject to income taxes.

Insurers levy fees on their annuities, and there's the rub. If you cash out too soon, the fees may overwhelm the value of the tax deferral. Most variable annuities, in particular, are loaded with charges. You might have to hold a variable annuity for 15 to 20 years for it to yield the same, after tax, as you'd get from a comparable mutual fund bought outside the annuity.

"Most of the benefits in variable annuities go to people who turn them into an income for life," says New York insurance analyst Glenn Daily.

Fixed annuities have fewer fees than variable annuities do. To make them pay, you have to hold them only long enough to avoid surrender fees and the 10 percent penalty for withdrawals under age 59 and a half. Even so, Daily says, "It is still advantageous to turn the investment into a lifetime income."

In short, if the president's proposal passed and today's deferred annuities didn't exist, the tax law would force you to make wiser choices. You'd keep out of annuities (especially variable annuities) if you didn't want to convert to a lifetime income; you'd buy annuities only if you truly meant to invest long term. For people who meant to invest long term and then found that they needed the money, some modest penalty could be imposed for early withdrawal.

Another good result, if the president's proposal passed, would be that fixed annuities could yield more, Daily says. If all buyers were locked in, insurers could invest for longer terms, at higher rates.

Today, the competition is forcing insurers to shorten the terms of their annuities rather than lengthen them, which generally makes the investment worse, not better. For these reasons, the Bush proposal deserves another look.

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