Variable annuities are not ideal for every investor investments and do have a few drawbacks to consider ahead of time. Variable annuities should be considered long-term investments subject to market fluctuations and investment risk.
Variable annuities contain fees and charges included, but not limited to, mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees, and charges for optional benefits and riders.
Variable Annuity Fees
Variable annuities often come with several types of fees, which may reduce your overall yield. It is important that you include these fees when comparing annuities with other investment options you may be considering.
If you withdraw money before the end of your annuity's waiting period, you will be required to pay a surrender charge. There may also be annual administration fees as well as fees charged by the mutual funds in your account. If your policy provides a death benefit, mortality and expense fees may apply
Annual fees for variable annuities can often be 2% to 2.5%, with some variable annuities that have annual costs as high as 4%. Compare that to the most broad market exchange-traded funds that have annual fees of 0.25%, mutual fund bond funds around 0.75%, large-cap stock funds around 1% and small cap and international funds around 1.5%.
Under most circumstances, if you are not at least 59 1/2 when you begin taking money out of the annuity, you will be charged a 10 percent early-withdrawal penalty tax on any gains on your investments.
Variable Annuity Taxes and Penalties
Once you do start to withdraw money, your gains will be taxed at your ordinary income rate, instead of a lower long-term capital gains tax rate. If your variable annuity goes up a lot in value over the years, the tax hit can be pretty significant.
If you start taking withdrawals before your retirement, there may be an increase in taxes due if there is a large enough difference between your ordinary income tax rate and the capital gains tax rate.
If you are not at least 59 1/2 when you begin taking money out of the annuity, you will be charged a 10 percent early-withdrawal penalty on any gains on your investments.
Variable Annuity Surrender charges
You're also likely to face an expensive surrender charge for withdrawing your money out of an annuity within the first several years after you buy it. The surrender charge usually runs around 7% of your account value if you leave after one year, and the fee generally declines by one percentage point a year until it gets to zero after year seven or eight. Some annuities come with even heftier surrender charges - up to 20% in the first year.
As mentioned above, Variable annuities should be considered long-term investments.
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