More Facts, Less Fiction...Please

I ran across an article from The Motley Fool called Variable Annuities: The Lowdown written on June 6, 2006. I guess they were trying to make a case against variable annuities.

As I read the article it seemed as though they either failed to look at variable annuities lately, or just have no idea what they offer now. I understand that they do not like them and they want everyone to own individual stocks and subscribe to their service, but if you are going to try to dethrone something you need better facts.

The one thing they did sight in their article is that you should do your homework on variable annuities before you invest. That is the only thing I whole heartedly agreed with and the reason Annuity IQ is here.

I have summarized what they wrote in italics below and my response is in regular print.

They can scarf up more than 2% of your holdings each year, according to Morningstar. On a $50,000 account, you'd be forking over some $1,000 annually.

Well, this is not big news, every investment has fees. Even no-load mutual funds can have fees in upwards of 2%, the average no-load fund still has fees of about 1% or so. The average loaded A share fund has expenses of about 1.25%, I do not hear them complaining about those fees and considering no-load funds offer no advice, what exactly are you paying for?

Earnings grow tax-deferred in a variable annuity, but when the tax is ultimately paid, it's at your normal rate, which might reach nearly 40%. Compare that with the long-term capital gains rate of just 15%.

Ah, yes the old 15% capital gains tax rate argument, this is an oldie but a goodie. Considering that much of the distribution from mutual funds are short term capital gains, which are taxed at ordinary income, this is an illogical argument. In 12 years in the investment business I have never seen any client take a lump sum distribution from an annuity and rarely from a mutual fund. Odds are you will tap your variable annuity as a stream of income, which may affect your taxes, but you would have to be taking a lot of income to reach the 40% income tax bracket.

It often takes at least 15 years before the performance of your variable annuity will match the after-tax returns of investments in a taxable account.

Huh? Where did they get this number from? No source, no data and zero information on how they came to this conclusion. In all the studies I have found tax deferred investments beat out taxable investments (the comparison is coming to Annuity IQ soon). I would love to pull numbers out of the air and pass them off as fact to, but I have a conscience.

The "death benefit," which will pay your beneficiaries at least as much as you put in to the annuity, is often a selling point. But it frequently costs more than it's worth. Long-term investments in good stocks are likely to increase, not just maintain, their value.

They also talk about the death benefit as a reason most people buy a variable annuity to begin with. First, let me say people are not buying variable annuities for their death benefit. They are buying them for their living benefits; I want to be clear about that. Long term investments should increase in value, but they do not always or have we forgotten the 200-2002 sell off? Also, variable annuities can have stock mutual funds, so are they saying all stocks go up except for mutual funds invested in a variable annuity? OK, that makes sense.

If you don't draw out the money before you die, your beneficiaries will be taxed on it. Mutual funds and individual stocks should cost your heirs a lot less.

Well, I have rarely, if ever, run into a client who was investing their money for their heirs. The vast majority of people I have spoken with and done business with are investing for themselves and their heirs come secondary. Also, is it really your concern with what your heirs get when you pass away?

If the answer is yes then purchase the enhanced death benefit riders that are designed to pay the taxes on your earnings to your heirs. I also have to say if you know of someone who passed away in 2000 to 2002 do you think their investments were up or down? It would not have mattered to a beneficiary of a variable annuity owner as they received at least the original investment back from the insurance company, because of the death benefit.

As with instruments such as IRAs, if you withdraw funds before age 59 1/2, you'll be charged a 10% penalty. Better be sure you won't need that money soon.

Exactly true, but anyone who recommends any equity investment for the short term is in serious violation of NASD rules and sales practices. All investment are long term no matter what they are, unless it is a savings account or money market account.

Variable annuities offer the option of annual payments. But you could achieve annual income effectively in other ways: by selling off small portions of stock holdings each year, for example, or investing in other income-producing securities.

They are talking about annuitization, which is rarely used as a selling point for a variable annuity. It is nice that they conveniently left out the fact that you can have living benefits on your annuity that do not require annuitization. They either did not know about them or they fear that it would negate their whole argument.

Another issue I have is they state in this segment is they are recommending that you own equities and to sell them off to generate income. This, again, negates their fee theory on annuities as selling stock involve commissions. Selling off securities will also generate, possibly, more taxes for you at the end of the year. Income producing securities will also be taxed at ordinary income, if they are referring to bonds of course. I can also point out several if not millions of investors who are no happy with taking income out of stock portfolios, mostly from 1999 to 2002. The market tanked and their portfolios went south and they ended up selling more shares of their investments at low prices to create the income they needed, their portfolios never recovered.

They also went on to say that IRA’s and 401 (k)’s are better places to sock money away. Now, IRA’s and 401 (k) plans offer a tax break and then grow tax deferred. It would seem to a regular person that they are speaking out of both sides of their mouth. They just laid out several reasons not to tax defer your investments, but then say IRA’s and other retirement plans are better, how? The couple hundred dollars the contributions save me every year? Don’t get me wrong you need to use these instruments, but the tax savings you get for making contributions are not Earth shattering. Especially considering a variable annuity allows you to save tax dollars every year because you do not receive a 1099 at the end of the year.

These are the same guys who made an appearance on Oprah in 1999 in their Fool getup and were telling people to buy stocks in what they liked. They made Tom Cruise and his jumping up and down on Oprah’s couch look like he was sane. After the market corrected itself and people lost trillions of dollars they made another appearance on Oprah. This time they were professional and very somber. It seems everyone is a genius when the market goes up, but when the market crashes what happens? You look, well, Foolish.

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