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Key Asset Classes vs. Variable Annuities

Original post by Ciaran John of Demand Media

Whether you are a retiree seeking income, a young investor saving for retirement or a speculator, there are many different investment options. Certain types of securities are referred to as key asset classes, and many people invest in these assets. However, if you are seeking more than just growth or income, then you might ` find that a variable annuity suits your needs.

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Investments

Traditionally, investment analysts have regarded stocks, bonds and cash as the key asset classes. However, many people also regard other types securities, including commodities such as gold and oil as key, while others break stocks and bonds down into several subgroups of key assets. Variable annuities are life insurance contracts that provide you with a lifetime income stream. Your purchase premiums are invested in selected mutual funds, or into fixed interest accounts. The mutual funds in a variable annuity contract typically use asset allocation models. This means that the fund manager has to buy and sell securities to ensure that the balance of stocks, bonds and cash remains unchanged over the course of time. The life insurance portion of the contract protects your family in the event that you die during the annuity term.

Tax

Variable annuity contracts are tax qualified, which means that your premiums grow on a tax-deferred basis. You can fund a variable annuity with pretax or after-tax money. Your earnings are taxed at the time of withdrawal along with any pretax contributions. Aside from paying income tax, you also have to pay a 10 percent tax penalty if you withdraw money from the contract before you reach the age of 59 1/2. Investments in key asset classes do not grow tax deferred unless you hold those assets within a tax qualified retirement account such as a 401(k) or an individual retirement account. Withdrawals from retirement accounts incur the same taxes and penalties as annuity withdrawals. Taxable investments grow more slowly than tax-deferred investments, because in a tax-deferred investment you can reinvest your annual returns without first having to pay tax.

Risk

When you invest in key asset classes you can try to arrange your investments so that you are protected during economic downturns. Stocks can provide you with growth, but you also stand to lose your principal if the stock market crashes. You can mitigate this risk by investing some of your money in bonds and cash since these key asset classes are less volatile. You can use the same strategy within an annuity because the cash value of your annuity can rise and fall based upon the performance of the underlying mutual funds. However, if the cash value of your contract plummets, you can choose to withdraw your funds periodically, rather than a lump sum. When you do this you are normally guaranteed to get back as least as much as you originally invested.

Cost

When you buy individual securities you normally have to pay trade fees. These costs are often higher if you invest in mutual funds because in many instances you have to pay an upfront commission known as a load. You have to contend with the same trade fees and loads when you have a variable annuity contract, but you also have to pay fees to the insurer. These fees cover the cost of the life insurance and the income guarantees. Furthermore, annuity contacts begin with an accumulation phase during which your funds are invested. Withdrawals during this phase normally result in a surrender penalty that often tops 7 percent of the contract value.

Considerations

If you want to buy the key asset classes, but want some safeguards, you can buy an annuity and invest in the key asset classes within the contract. However, if the market performs well, then you end up with less at the end of the annuity term than if you had invested directly into the key asset classes. This is because the insurer's fees deplete your earnings. You can potentially get the best of both worlds, and save some money in fees if you invest directly in the key asset classes, and buy a term life insurance contract. However, while doing this gives your heirs the same kind of protection that an annuity provides, a term life contract does not provide you with any living income benefits.


                   

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About the Author

Ciaran John began writing in 1994 with contributions to "The Hourly Press" and "The Sawbridgeworth Observer." He holds a Florida Life, Health and Variable Annuity license as well as series 6 and 63 securities licenses. He has a Bachelor of Arts in theology from Kings College in London.


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