Friday, October 4, 2019

Introduction to Variable Annuities

By:      Michael D. Handelsman
            Sallah Astarita & Cox, LLC

            Variable annuities offer investors the opportunity to participate in the stock market while providing the protection of an insurance product. Variable annuities offer investors a menu of investment choices, usually mutual funds. The value of the annuity is directly affected by the performance of the investment choices made inside the annuity. Eventually, investors in a variable annuity receive a stream of payments over time or a lump sum payment.

            Prior to investing in a variable annuity it is important for potential investors to receive and review the prospectus for the product. The prospectus contains important information regarding the risks associated with the annuity and the features of the product. Upon receipt and review of the prospectus an investor should ask their financial professional any questions they may have about the product.

Too often, investors ignore the prospectus, only to find out years later that there was language contained therein that would have given them pause prior to their investment. Further, during a later dispute regarding the product, if a prospectus was received by an investor, it will be presumed that the investor was aware of the contents of same. Take the time and read the prospectus and other offering documents.

            It is important to note that variable annuities are not appropriate for short-term investors. They are designed as long-term retirement savings products. Investors may be charged penalties or taxes as a result of early withdrawals. Therefore, variable annuities are not a good choice for short-term investing.

            In addition, considering that variable annuities are not suitable as short-term investments, variable annuities are also not appropriate for all investors. For example, an annuity is less likely to be suitable for an investor at an advanced age or an investor who will need access to the funds in the near future for big purchases such as a house, or paying for college for a child or children. It is important to consider how a potential investment in an annuity fits with an investor’s overall financial plan.

            As with all investment products, variable annuities are not guaranteed to result in profit. Since a variable annuity invests in underlying mutual funds, the risk present when investing in variable annuities is similar to that of traditional investing in mutual funds or the stock market.

            That being said, there are important differences between investing in a variable annuity and a mutual fund. Unlike mutual funds, variable annuities offer individuals the ability to receive a stream of periodic payments for the rest of their life, or the life of a spouse.

            Many variable annuities offer a death benefit. If an annuity owner dies prior to receiving payments, a named beneficiary will receive a specified payment. Often the inclusion of a death benefit will result in higher costs of ownership of the product.

            The owner of the annuity will not pay any taxes on any income or investment gains created by the underlying investment choices made in the annuity. However, when the money is taken out, the earnings will be taxed as ordinary income, as opposed to at the capital gains rate, and a 10% tax penalty will be applied if money is withdrawn prior to the annuitant reaching the age of 59.5. It should also be noted that there is no extra tax advantage if you are putting a variable annuity in a tax advantaged account such as an IRA or 401(k).

            It is important that your financial professional explain all fees and charges associated with the proposed variable annuity. Often, withdrawals made during the first few years that an individual owns a variable annuity will result in "Surrender Charges." Also, different investment options offered by the annuity may result in different expenses and charges. There are countless features that can be added to a variable annuity. However, in most cases there will be additional charges associated with these features.

            The Financial Industry Regulatory Authority (FINRA), a regulator of the securities industries, has issued guidance to financial professionals to help protect the investing public from being placed in unsuitable variable annuities. According to FINRA, the myriad features available with variable annuities make the suitability analysis particularly complex.

            Prior to recommending that their client invest in a variable annuity it is important for the firm/financial professional to gather comprehensive information about their customers including their age, number of dependents, investment objectives, risk tolerance, tax status, net worth, and annual income.

            Financial professionals should also have a thorough knowledge of the specifications of each variable annuity recommended and discuss expenses, fees, and liquidity issues with their client. Furthermore, as mentioned above, financial professionals should only recommend variable annuities to those individuals who have a long-term investment objective.         

            FINRA also recommends that firms establish special procedures to insure that their financial professionals are not recommending variable annuities to individuals whose age makes this long-term investment inappropriate. Depending on the clients’ age, any investment in a variable annuity may be unsuitable.

            Variable annuities are highly complex financial products that offer an almost limitless number of features and options. The nature of variable annuities makes the suitability analysis performed by financial professionals and firms highly complex. It is important for firms and financial professionals to only recommend variable annuities that are suitable for their clients.

            If you would like to discuss the suitability of your variable annuity investment, please contact Sallah Astarita & Cox, LLC at 212-509-6544.

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