Dear Jeff: I'm 50 and plan to retire in ten years or so. I have a government retirement plan that will pay me between $850 and $1,300 a month when I am 55. I have a small amount in a government-sponsored deferred compensation plan ($6,576 today), a higher education retirement matching fund into which has been going 14 percent of my monthly salary for one and a half years, and a variable annuity whose value today is $62,000. My husband also has a 401(k) into which he has been contributing and an employer has been matching the contributions for about four years. We will both be getting (I hope!) Social Security.
My question: I was thinking about getting a Roth IRA, but my husband says we should invest in the variable annuity, because the bigger the pot, the more we will earn on future investments. What do you think? I like the benefits of the Roth IRA, but would it be wiser to put our money into the bigger pot? Thanks for any advice.
Jeff Says: If you put the same amount of money into two funds, one large and one small, which invest in the same companies and in the same percentages, your returns for each fund will be identical regardless of the size difference. Therefore, I agree with you and disagree with your husband that you should invest in one vehicle rather than another because it is a "bigger pot." If you invest your Roth IRA in a mutual fund, then your pot may actually be larger.
Your decision should actually be based on the appropriateness of each type of investment and by comparing the advantages and disadvantages of each. For instance, your contributions to the Roth are limited to a maximum of $2,000 per year, compared to no limitation on a variable annuity. Withdrawals from each are treated differently for income tax purposes and should be examined carefully.
Perhaps the biggest drawback to the variable annuity will be the higher charges associated with it. The trade-off is that the investor receives a guaranteed death benefit and a guaranteed income for life, obviously something a mutual fund cannot provide. For more information, you can read an earlier column on The Facts About Variable Annuities.
As you can see, both investment vehicles can be attractive. Perhaps you should consider investing $2,000 into a Roth and the balance of your funds in a variable annuity so that you will have the benefits of each.
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