Insider Jeff Fleming

Annuities: Fixed or Variable?

This week, Jeff discusses some of the pros and cons of fixed and variable annuities. Also, how to cut taxes on the sale of a home.

Dear Jeff:
I have a fixed annuity of $250,000 that has three years to go before I can take out more than 10 percent with no penalties. (I am 60 years old.) Should I transfer this annuity into a variable annuity that I can use now with no penalty? (As I am told by a local consultant.) Or should I take out the taxable portion annually, down to the original investment, and take out the entire amount in three years and invest it elsewhere?

Jeff Says:
The advantage that a variable annuity has over a fixed annuity is that its investment accounts provide you with the opportunity and potential of earning a higher return. Of course, you also take the risk that you may experience a loss during your holding period as well.

If you transfer your existing fixed annuity now, you should double check to be sure that you will not incur a surrender charge. If you are still subject to a charge, then you will need to earn substantially higher returns with the variable annuity to make up for the percentage charged to you for the early withdrawal.

You also need to determine whether or not the period of surrender charges will begin again on the transfer so that you will not be surprised when you need to withdraw the funds. These questions can only be determined by reference to the variable annuity prospectus and annuity contracts.

It may be wise to transfer to a variable annuity despite any surrender charges if you are willing to invest somewhat more aggressively to earn the possible higher returns. If you establish a portfolio with an expected return of ten percent, for instance, and the fixed annuity is only paying six percent, then you may recoup any additional charges caused by the transfer in as little as one or two years. Of course, returns are not guaranteed. If you intend to invest very conservatively, then you should probably stay with the fixed annuity.

As far as taking the money out of the annuity entirely, it is probably not a good idea because of the amount of income taxes that would result. Additionally, the annuity can guarantee an income to you for the rest of your life, which most other investments do not offer.

More Advice: Cut Taxes on Home Sales