Advantages of the Variable Annuity
 


This chapter is going to focus on the major features, benefits and advantages of an annuity in general and then focusing on a variable annuity. When considering these benefits, look at them as selling points.

Popular Aspects

The last chapter introduced some very popular aspects of annuity investing. Some of these advantages were:

1.     Fixed rate annuities are "safe" in that no one has ever lost a penny in a fixed rate annuity. Some annuities operate on a schedule of a fixed rate for a guaranteed period. After this guaranteed period of time, the rate is set by the annuity portfolio's earnings. Thus the rates can vary based on what the underlying assets are earning. As interest rates go up, the earnings on the asset base go up. All this on top of the tax-deferral benefit.

2.     For clients looking for a place to put the retirement money, fixed rate annuities offer a "safe" environment. In fact, many fixed rate annuities not only guarantee the principal, but also that the client will receive at least the original premium back if the annuity is surrendered early (minus any surrender charges). There is no market risk with a fixed rate annuity investment.

3.     Annuities offer the contract owners investment diversification. We may hear quite often that asset allocation is more important than selection. However, a deferred annuity can play an important function in asset allocation. Prospective clients may want to start diversifying assets and allocate bond investments to deferred annuities. How do the clients benefit? Those who invest in deferred annuities, benefit by receiving investment safety, a higher yield, no market risk (with fixed rate annuities) and of course, compounding interest tax deferral.

4.     Annuities offer the contract owners tremendous tax benefits. A deferred annuity enables the client to avoid paying taxes on the interest earned until it is annuitized (systematic payments). Selling point: a tax deferred investment is more powerful than taxable even over short periods of time. The interest stays in the investment, compounding the earnings received.

5.     For those wanting a fixed rate annuity, it is a simple product. There is no prospectus, no underwriting and basically no hassle. For the clients wanting a very simple investment, fixed rate deferred annuities offer charges up front, yearly fees, surrender penalties, liquidity provisions, stable rates and rate histories that can be looked to. Most annuities do not have up-front or yearly fees. It is also simple in that there is no medical examination required, no attending physician statement (APS), and no Securities Exchange Commission (SEC) or National Association of Securities Dealers (NASD) forms. If the client does not want to invest in a fixed rate annuity because the rates are seemingly too low, one could offer to put a portion of the funds in that the clients may want to be "safe." The New Century Family Money Book by Jonathan Pond suggests: "Since nothing in personal financial planning is either/or, you may want to divide your deferred or immediate-pay annuity purchases between fixed and variable annuities. The net result will be the holding of 'balanced' annuities."

Variable Briefing

A variable annuity is a hybrid vehicle that is almost exclusively an investment, but a small part of it deals with insurance. This insurance feature is referred to as a guaranteed death benefit. An annuity is an insurance policy. Proceeds are paid to the beneficiary in the event of the contract owner's death prior to the annuitization date. The guaranteed death benefit is the amount paid to the beneficiary and is always at least 100 percent of the investor's total contributed funds, less prior withdrawals and prior applicable surrender charges. At the death of the contract owner, all future surrender penalties are waived, regardless of the time of ownership.

In simple terms, a variable annuity is an investment company or entity that makes investments on behalf of individuals and institutions that share common financial goals. The sub-accounts, or portfolios, pool the money of many people, each of whom invests a different amount. The initial investment required varies from annuity to annuity.

Expert money managers for each sub-account use the pooled money to buy a variety of stocks, bonds or money market instruments that, in their opinion, will help the sub-account's investors achieve their financial goals and objectives.

Variable annuities came into existence in 1952.

Each sub-account's investment objective, which is described in the prospectus, is important to both the portfolio's manager and the prospective investor. The money manager uses it as a guide when choosing investments for the sub-account. Prospective investors use it to determine which sub-accounts are suitable for their needs. Each investor, by law must receive a prospectus prior to or at the time of the investment. The prospectus details investment objectives and restrictions as well as of the costs and expenses associated with the investment. Variable annuity investment objectives cover a wide range. For the investors in search of higher returns, follow aggressive investment policies that involve greater risk, while others draw current income from more conservative investments.

Variable annuities are gaining popularity because they are convenient and efficient investment vehicles that give all investors access to a wide array of options. Variable annuities allow an opportunity to participate in foreign stock and bond markets, which for most of us would be inaccessible because of the time, expertise or expense. International sub-accounts make investing across sovereign borders no more difficult than investing across state lines.

Variable annuities came into existence in 1952, through the work of economist William Greenough, an economist with the Teachers Insurance and Annuity Association. Greenough wanted a retirement vehicle comprised of equities, to counterbalance post-World War II inflation. As income tax rates increase and company retirement benefits decrease, individuals must take on a larger role in their own retirement planning. Annuities have become one of the primary vehicles for avoiding taxes until distribution and building a larger nest egg faster than other taxable investments.

1997 Tax Law Hits Variable Annuities Hard

Before we continue on with the advantages of the annuity, it should be stated that the passing of new tax laws vastly affects investments from time to time. One such example of this is the passing of the federal Taxpayer Relief Act of 1997 (TRA '97), signed into law by President Clinton in early 1997. This new tax law changes the way investments will be taxed. This new law could make variable annuities very unappealing.

"Variable annuities are going to be very unattractive going forward because the alternatives have become much better," say Tim Kochis, partner in the San Francisco financial planning firm of Kochis & Fitz. "We've run the numbers with a variety of situations, and we can't find one where the variable annuity come out on top of investing in a taxable index fund."

The new law affects investors like this: Invest in a stock index and, under the new law, an investor pays a maximum 20 percent capital gains rate when they cash it out. This is assuming that the investor held the investment for at least 18 months. Even though a variable annuity accumulates tax-deferred, an investor's income will eventually be taxed at their ordinary income tax rate, which could be at least 50 percent higher.

Under the old law, capital gains rates were 28 percent. The ordinary income tax rate for most Americans ranges between 28 percent and 36 percent. For those Americans earning somewhere over $200,000 annually, their tax rate tops out at 39.6 percent. The Taxpayer Relief Act drops the capital gains rates to 20 percent for those in the highest tax brackets and as low as ten percent for those lower tax brackets. Basically, an investor could pay 20 percent tax on a mutual fund versus paying perhaps 31 percent to 36 percent tax on a variable annuity when funds are eventually paid out. Taxpayers in the 15 percent bracket, who previously paid a capital gains tax of 15 percent will now pay 10 percent. Though, capital gains tax on shorter term investment must still be paid at the taxpayer's income tax rates. The new rates and longer holding periods apply to investments sold on or after July 29, 1997. An investor can use both the new rates and the one year holding period for investments sold between May 9, 1997 and July 29, 1997.

For example, a soon to be retired investor wants to withdraw money from his variable annuity. The investor would get back their initial investment tax-free, but they would have to pay tax at their ordinary income tax rate on the investment earnings in that annuity account. The investment earnings are likely to make up the majority of the annuity account value. This means they could be taxed anywhere from 31 percent to 36 percent. If this same investor invested in mutual funds, their dividends and realized short-term capital gains rates are taxed as they go at their ordinary income tax rates. There are also unrealized gains for the investor - the rising value of their unsold shares that are not taxed until they sell them. When the investor does sell them, they are taxed at preferential long-term capital gains rates. This means they could be taxed anywhere from 10 percent to 20 percent.

"With their capital gains reduction, the people selling

variable annuities are going to have to come up with very

creative arguments about why these products make sense."

- Philip J. Holthouse of Holthouse, Carlin & Van Trigt Tax Accounting Firm

On top of the capital gains reduction, variable annuities also have another hard hitting negative pushing them down further. Variable annuities have annual insurance expenses that usually come with a variable annuity. The insurance element of the annuity is what provides the tax benefits. Some consider this insurance "wrapper" very expensive when considering that annuity insurers charge between 1 percent and 1.5 percent of the account value each year to pay mortality charges and insurer expenses. This further lessens the return paid to investors.

In the October 1997 issue of What's Next issued by Farmers Insurance it relates this about the impact of the Taxpayer Relief Act of 1997 on variable annuities: "Many financial analysts have traditionally recommended that investors hold variable annuities 10 to 15 years in order to break even with mutual funds. In other words, it typically took that long for an annuity compounding tax-deferred to compare favorably, on an after-tax basis, with mutual funds. Some analysts now estimate that with the lower maximum capital gains rate of 20%, the break even point for most investors will be at least 20 years, not a very enticing investment feature even for a young investor.

"On the other hand, there are reasons to believe the lowered capital gains tax will not deal as severe a blow to variable annuities as might otherwise be indicated. Certain funds, such as those which have high portfolio turnover or rely on corporate dividends or bond interest, do not qualify for long-term capital gains treatment. The break-even holding period for such funds will remain relatively short. Also, the appeal of annuities goes beyond tax deferral. For example, the annuity death benefit is an insurance-like feature that protects heirs from a stock market decline when the annuity holder does. Finally, unlike investors in mutual funds, annuity holders can switch funds from one money manager to another without triggering a taxable event."

An article in the Tacoma News Tribune published August 17, 1997 related: "Should you cash out your variable annuity and buy an stock index fund instead? 'No,' says Philip J. Holthouse, partner with the Los Angeles-based tax accounting firm of Holthouse, Carlin & Van Trigt. "'If you do, you'll pay tax on the annuity proceeds at your ordinary income tax rates, plus- assuming you aren't already age 59 1/2- you'll pay a 10 percent federal tax penalty.

"'You simply shouldn't put any more money into a variable annuity without doing a detailed analysis of whether an annuity will net you as much after-tax income as a simple stock market mutual fund.'" published by Kathy Kristoff, syndicated columnist.

In the past, the insurance industry has always come up with investment solutions to counterbalance developments such as these. We simply have to wait and see what annuity contracts can be enacted to again attract and benefit the investor.

Some of the advantages remain the same, even with the above disadvantages.

The federal Taxpayer Relief Act of 1997 also included several changes to current Individual Retirement Accounts (IRAs). Some of the new provisions allow more people who participate in their employer's retirement plans to take advantage of traditional tax-deductible IRAs. Another provision applies to couples in a situation in which only one spouse is eligible to participate in a company retirement plan. Under TRA '97, the income limits affecting whether taxpayers without access to company retirement plans can still make deductible contributions to a traditional IRA will gradually increase over several years.

Effective January 1, 1998 the Taxpayer Relief Act adds two new types of IRAs:

1.     The Roth IRA, and

2.     The Education IRA.

The Roth IRA is named after Senator Roth of Delaware. The Roth IRA is a nondeductible IRA, but with the added twist that qualified contributions of up to $2,000 per year are not subject to either income tax or penalty. The maximum contribution is phased out for individuals with adjusted gross income (AGI) between $95,000 and $110,000 and for joint IRAs with adjusted gross incomes between $150,000 and $160,000. This means that some taxpayers who have the money to contribute will not be able to participate.

The Roth IRA lets an investor withdraw their contributions and earnings in the first tax year, five years after first being contributed without taxes or penalties under certain stipulations:

The Education IRA was developed to combat the higher education expenses of the taxpayer's designated beneficiary. Contributions to the account are nondeductible and limited to $500 per year per child. No contributions are allowed to be made after the beneficiary attains age 18. There are no taxes or penalties on contributions or earnings that are withdrawn from the account to pay qualified college expenses.

Major Advantages

1.     Tax-deferred Accumulation

2.     Flexibility

3.     Reallocation of Assets

4.     No Sales Charges

5.     Surrender Penalties versus Free Withdrawals

6.     Guaranteed Death Benefit

7.     Avoids Probate

8.     Distribution Options

9.     Safety

10. Liquidity

11. Inflation Protection

12. No Investment Ceiling

Tax-Deferred Accumulation

Overcoming sales objection requires knowing the hurdles and differing opinions about the products offered. This helps to formulate a presentation that is effective and avoids "conversation stoppers."

Since we have gone over the tax benefits already, we will just briefly state the obvious. An annuity's earnings accumulate tax-deferred. This means that contributions, earnings and money ordinarily taken by taxes, remains in the account and continues to grow without current federal, state or local taxation.

This triple compounding through tax deferral produces a return on all invested money. Triple compounding means a client could earn:

1.     Capital gains and interest on the principal,

2.     Capital gains and interest on the earnings, and

3.     Capital gains and interest on the money that is normally lost to taxes.

Flexibility

The options of the fixed annuity investment are straightforward and limited. There are two primary decisions: selecting a maturity date and interest rate. As with certificates of deposit (CDs), the fixed annuity interest rates are a function of the fixed-income markets. Fixed annuities offer either one year guaranteed rates with annual renewals or interest rate guarantee periods from one to ten years, depending on the insurer.

Variable annuity options are much more diverse. Annuity contracts offering 10 to 20 sub-accounts, from aggressive growth to money markets, are very common. One may be able to find a variable annuity that offers a fixed sub-account similar to fixed annuities.

Reallocation of Assets

A contract owner of a variable annuity has the ability to reallocate (switch) assets between sub-accounts to change an asset allocation mix without creating a tax liability or being subject to commission charges. This can be a big advantage when compared to other investment financial transactions. For instance, the sale of a mutual fund or security in an Individual Retirement Account (IRA) can incur a tax liability.

An investor can also transfer one fund complex to another with 1035 exchange, and not incur a tax liability. A variable annuity can be an attractive vehicle for market timers who want to switch aggressively. Normally, an investor would not face any charges for switching, but may be limited to a certain number of changes.

No Sales Charges

Most variable annuities do not charge a front-load sales charge (commissions). This translates into a benefit for the client; a hundred percent of the money they invested into an annuity is earning an immediate return.

Surrender Penalties versus Free Withdrawals

Most annuities provide systematic withdrawals (annuitization) and periodic withdrawal options to contract owners. These withdrawals are not subject to surrender penalties unless they exceed certain withdrawal limitations or restrictions.

Available annuity withdrawal option vary from contract to contract, but many have common features, which may include:

    A minimum account value to qualify for a withdrawal option.

    A minimum withdrawal amount for each distribution.

    A maximum number of withdrawals per contract year.

    Withdrawals that are made will be deducted proportionally from each sub-account invested in unless otherwise directed by the contract owner.

    Any withdrawal is subject to federal income taxes on the taxable portion.

    A ten percent IRS penalty will be assessed on withdrawals if the contract owner is under the age of 59 1/2

    Withdrawals may be modified or discontinued at any time prior to annuitization.

    If the contract owner makes regular, periodic withdrawals, part of each withdrawal is treated as taxable income. The rest is the nontaxable return of the contract owner's capital - initial invested amount made with after-tax dollars.

    If the contract owner makes occasional withdrawals, subject to no particular schedule, the entire withdrawal is treated as taxable income. Taxes are levied until the contract owner has taken all of the interest that their money has earned. After the interest portion of the annuity is withdrawn, the contract owner may start withdrawing the original investment - tax free.

It may sound odd to view penalties as a benefit. But knowing all the characteristics of annuities can make these positives when looking at other investments with higher charges. There are ways to avoid the IRS and insurer penalties. For penalties to be avoided one of the following must occur:

    Death of the annuitant,

    Disability of the annuitant, this may not apply to all insurers,

    Annuitization (simply defined as a "contracting for a series of payments from an annuity"),

| The following applies specifically to insurer penalties:

    Limit the withdrawals to those allowed under the free withdrawal privilege,

    Wait until the penalty period lapses, or

    Adopt a systematic withdrawal plan of up to ten percent a year.

| The following applies specifically to IRS penalties:

    The contract owner reaches age 59 1/2 or older.

Guaranteed Death Benefit

When an investor invests in a variable annuity, it automatically contains a guaranteed death benefit. The guarantee is that upon the death of the annuitant, the beneficiary will receive the greater principal, plus any additions. Or the value of the account at the annuitant's date of death. The guaranteed death benefit is based on the greater of investments made by the contract owner, or the value on the date of the annuitant's death, whichever is higher.

The guaranteed death benefit basically means that upon the death

of the annuitant, the beneficiary will receive the greater principal,

plus any additions.

This guaranteed death benefit lasts until the contract owner terminates the annuity contract, annuitizes the contract, the annuitant dies or the annuitant reaches the age limitation of the annuity contract which can be between 75 and 80, depending on the annuity contract.

Avoids Probate

At the death of the contract owner, the annuity's value will transfer to the designated beneficiary or the joint owner avoiding probate proceedings. There are no delays and the beneficiary receives immediate access to the annuity. If the beneficiary is the surviving spouse of the contract owner, the spouse may assume contract ownership and continue the contract as if the contract owner had not died.

The Federal Tax Code sets certain distribution requirements for beneficiaries other than spouses:

1.     If the contract owner dies prior to the annuity maturity date, the proceeds must be distributed within five years following the contract owner's death.

2.     If the contract owner dies on or after the maturity date, but before the entire interest in the contract has been distributed, the remaining interest must be distributed at least as rapidly as under the method of distribution being used at the time of the death of the contract owner.

The value of the annuity is still included in the estate

of the deceased for federal estate tax purposes.

Both of these requirements are considered met if the portion of the proceeds is payable to the beneficiary over a period not exceeding their life expectancy or distributions begin within one year after the death of the previous contract owner.

It should be noted that while the beneficiary inherits the annuity proceeds tax-free, the value of the annuity is still included in the estate of the deceased for federal estate tax purposes. Only under strict circumstances can annuity proceeds pass completely tax-free. A tax specialist should be consulted for the most accurate and up-to-date information. All states allow the direct transfer of annuity assets to the beneficiary.

Distribution Options

Annuities offer a number of distribution-at-death options available to owners of nonqualified annuity contracts. They require ownership, an annuitant, and beneficiary designations by the contract owner.

The most used distribution options are:

1.     Lump-sum distribution: The contract owner withdraws the entire annuity value in one payment - lump sum.

2.     Lifetime income: The contract owner annuitizes the annuity and can then receive an income for life.

3.     Lifetime income with Period Certain: The contract owner annuitizes the annuity and receives an income for life and a guarantee that a certain number of payments will be made to a beneficiary if they die prematurely. Annuitization provides an even distribution of both principal and interest over a period of time. It only subjects a portion of the amount withdrawn for that year for taxation. A person can select to annuitize all or just part of the annuity. Once selected and the first check has been cashed, there is no turning back.

4.     Systematic withdrawals: The owner determines their distribution needs and systematically withdraws that amount without annuitizing the contract.

5.     No withdrawals: The contract owner makes no withdrawals, therefore letting the assets grow tax-deferred until their death, which would then pass the money directly to the named beneficiary.

Safety

Fixed annuities are backed by the insurer, required by law to have reserves. In fact, the reserve requirements for an annuity are much higher than for a bank account. For every dollar that is invested in an annuity, the issuing insurer must set in their reserves over a dollar. The insurer only uses these excess reserves to settle the withdrawals and redemption of annuity owners. The insurer is limited to using these reserves for only those things. The reserve requirements established vary from state to state. The insurer may invest only in certain types of investments in order to preserve the integrity of the reserve accounts.

The preservation of capital and the return of capital are major concerns of investors. Annuities guarantee that the beneficiary will receive either the original principal amount invested, less withdrawals, the current market value of the account or the guaranteed stepped-up value, whichever is greater at the contract owner's death.

Variable annuities have an additional safety feature

in that the securities for the underlying portfolios

in which the annuitant invests are held by a trustee.

The regulations required by the various state insurance commissions assure annuity owners that their principal and earnings are protected and that their annuity contractual obligations will be met.

Liquidity

The availability of assets is a major concern for investors. Since an annuity is subject to certain distribution restrictions and penalties for early redemption, a complete understanding of the distribution options. Annuities offer a wide range of penalty-free distribution options to meet any financial need that may arise. For instance:

It is important to emphasize that withdrawals of gains are taxed at ordinary income rates and may also be subject to a ten percent IRS penalty tax if made prior to the contract owner reaching the age of 59 1/2.

Since there are so many experts with so many opinions, we often find opposing opinions about the same subject. In their book, How Mutual Funds Work, Albert J. Fredman and Russ Wiles list as a disadvantage the illiquidity for variable annuities. They state this: "The surrender charges and the 10 percent penalty on distributions before age 59 1/2 make it costly to pull money out of variable annuities prematurely."

It is also interesting to note that they also list as a disadvantage the tax-status risk: "It is difficult to predict what kinds of changes in federal tax laws will occur in the future and how they might affect annuity owners. If you are considering a large investment in a variable contract, it would probably make sense to seek competent tax advice."

Inflation Protection

Variable annuities have two inflation-proofing features:

1.     An interest rate that moves upward with open-market interest rates, and

2.     The tax deferral that allows the interest to compound without tax erosion.

A key consideration for investors trying to inflation proof their investments is that there be proper balance among several different investments. Variable annuities offer an investor different investments fields thus providing a portfolio that is balanced. During a time of inflation and high interest rates, tax deferral is more important for dollar investments than for any others, since high interest rates mean that dollar investments will be producing more taxable income. Thus a device for deferring taxes will be especially valuable if it can be used to shelter assets denominated in dollars.

Variable annuities also have two deflation-proofing features:

1.     Provides a way of holding dollars without a prohibitive loss of purchasing power, and

2.     A deflation could make the guaranteed minimum interest rate extremely valuable.

No Investment Ceiling

Unlike tax-qualified retirement plans, an investor faces no maximum on what they can invest during the pay-in or accumulation period. Some experts recommend that investors invest as much as they can in regular retirement plans, such as the 401(k), IRA and Keogh before starting to think about a variable annuity.

Major Features

This chapter has covered some major benefits of annuity investing. There are also features of the annuities that make this a unique investment. This chapter will be covering the following features:

1.     1035 Tax-Free Exchange,

2.     Free-look Period,

3.     Social Security Income Exclusion,

4.     Investor Control,

5.     Professional Money Management,

6.     Unlimited Contributions,

7.     Commission Charges, and

8.     Reserve Requirements.

1035 Tax-free Exchange

If an investor determines that the current insurer's interest rate or company rating is too low, they have the option of a tax-free 1035 exchange. It should be noted that an investor would not want to continually change insurers. Why? Because when you change annuities, the surrender charge period starts all over again, thus they are locked into that insurer for a period of time. A 1035 Exchange is basically the exchange between two different products or insurance companies. It is known as tax-free since the investor does not pay any taxes, but it is only tax free if the investor does not see any of the money. The transfer must be between insurance companies or products. While a 1035 Tax-free Exchange will not incur a tax liability, the investor may incur insurer surrender penalties. An investor can do as many 1035 Exchanges as they want; there are no limits.

Before exchanging one annuity contract for another, there are some considerations that should be looked at:

1.     Is the new annuity contract offering a more competitive and/or diversified program?

2.     Does the new annuity contract increase the guaranteed death benefit?

3.     Is the new insurer rated highly by more than one insurance rating company?

A 1035 Exchange is basically an exchange of annuity funds

between two different products or insurance companies.

There are also the disadvantages of a 1035 Tax-free Exchange. We've covered the disadvantage of starting the surrender penalties all over again and any current insurer penalties incurred. So the investor could be liable for early withdrawal penalties making the transferred assets subject to surrender charges. Insurance companies are always improving their products so that investors will stay where they are. To discourage 1035 Exchanges, some annuity contracts that are no longer subject to surrender penalties may not include a "beefed-up" guaranteed death benefit provision in the contract.

Free-look Period

Most annuity contracts include a provision that allows the investor a certain period of time to cancel the annuity contract, normally ten days or longer, depending on the individual state's legal requirements and regulations. This "right to examine" gives the investor the power to change their minds. Should the contract owner/investor decide to cancel, in most states they will receive the greater of the purchase price or the value of the accumulation account, less certain charges for mortality and expense risk charges, administration fees and states taxes.

Social Security Income Exclusion

Social Security retirement income may be subject to federal income tax when Social Security benefits are added to other income and the amount exceeds certain limits. Among revenue sources included in other income are earned income, dividends, capital gains, interest and tax-free interest. The limits are:

1.     Single $25,000,

2.     Married filing joint $32,000,

3.     Head of household $25,000, and

4.     Qualifying widower $25,000.

Nondistributed annuity earnings are not included in any Social Security taxation calculations. This allows Social Security recipients to continue accumulating tax-deferred wealth in their annuities without creating a tax liability.

Investor Control

We are trained to meet certain needs of our clients. One of those concerns is having sufficient assets to maintain a reasonable lifestyle after retirement. In fact, this may probably be their biggest concern. Annuities offer these clients the ability to accumulate wealth, the opportunity to maintain control over those assets and the final decision on the distribution of those assets. The annuitant, contract owner, of the annuity determines the amount of the contribution, the investment options, the asset allocation model, the investment time period, when and how the assets are distributed and who receives the assets at the annuitant's death.

Professional Money Managers

Chapter one dealt with the feature of the professional money managers that are easily accessible for our client's needs. The assets of the variable annuity sub-accounts are managed by some of the most qualified and successful money managers available in the insurance industry. They offer investors access to institutional management, competitive and consistent returns over the long term and the assurance of expert oversight. Each sub-account is managed to meet a specific investment objective. An investor can choose between aggressive growth, growth, balanced, fixed-income and money market sub-accounts to develop a diversified portfolio. The investor can also be assured that the money manager of each sub-account seeks to maximize the investment for the least amount of risk as possible to meet the sub-account's objective.

Unlimited Contributions

Unlike quite a few retirement plans, contributions for the purchase of an annuity are not limited by federal statute. No portion of the annuity contribution is tax deductible. This is an attractive feature for some investors seeking to defer income until either their income has declined or they wish to pass the proceeds to a beneficiary while avoiding probate procedures (though the annuity is included in the estate of the deceased for federal estate tax purposes).

Commission Charges

When an investor invests in an annuity, no portion of the investment is taken away for commission charges. While the agent may not like the lower commissions, this is a big advantage for investors. This means that a 100 percent of the invested amount is immediately working for the intended goals of the investor. The investor will not lose any principal and/or interest earned to pay a commission when the money is partly or completely withdrawn. The insurer pays the commissions.

For these reasons, annuities can be referred to as no load or commission free since any commission paid comes from insurer directly. However, not all share this viewpoint. Jane Bryant Quinn, in her book Making the Most of Your Money, states this: "Never buy from an agent who claims that the annuity is 'no load.' All agents earn sales commissions, and all customers pay them, in one way or another. The costs are built into the annuity's structure. Any salesperson who deceives you on this point will deceive you and others."

"Never buy from an agent who claims

that the annuity is "no load.""

She goes on to relate: "On a classic single-premium deferred annuity, a 4 to 5 percent commission is pretty standard. On certificates of annuity, the commission may be 1 percent, plus another 1 percent each time you renew. No knowledgeable customer will deal with agents who collect 10 or 11 percent commissions. Such agents pick annuities in their own interest, not yours. The traditional declining-surrender-charge annuities sold at banks often contain 10 percent commissions, by the time the bank, the insurance company and the salesperson take a cut."

Reserve Requirements

A very understated benefit of annuity investment is the reserve requirement for an annuity account is much higher than for a bank account. For every dollar the investor invests into the annuity contract, the insurer must set aside over a dollar into the reserves. The insurer can only use these excess reserves to settle withdrawals and redemption of annuity owners.

Most states requires that insurers doing business in the state become part of the legal reserve pool. This reserve pool protects annuity investors and others who purchase life insurance products. In the United States, there are over 2,000 different life insurance companies. Collectively, the insurers own, control or manage more assets than all the banks in the world combined. This translates into financial clout that is advantageous to the investors they represent.

In the early 1920s, the US government began using annuities to fund government retirement accounts, as did the labor unions. Due to the requirements the government mandated, the insurance industry came up with two safety features:

1.     A guaranteed minimum interest rate built into the annuity contract and

2.     The reinsurance network.

Backed by the insurance companies' reserves, a reserve system for annuities was first introduced during the 1920s. The legal reserve system required then and now that insurers keep enough surplus cash on hand to cover all cash values and annuity values that may come due at any given time. It is these reserves that enable the minimum interest rate guarantees to exist.

The reinsurance network was designed so that if there was a large run on the money in the insurance industry, no one company would be required to take the brunt of the loss. The insurance companies spread the risk out among all of the companies that are offering similar products. Because of these reserves, annuities were primarily unaffected by the stock crash on October 19, 1987, "Black Monday."

In Summary