August 10, 2009

Example Variable Annuity Return

A while ago I caught an episode of Suze Orman's show and she had a caller with a Variable Annuity.

The caller had invested $600 a year for 24 years. That is a total of $14,400 paid in premiums. The value of the annuity was $13,200. So she lost money in the investment over a 24 year period. That is a pretty bad investment return.

Its possible that they had made very poor investment choices to cause the losses. But what if you'd simply thrown $600 into an S&P 500 index fund every year for 24 years? You'd have around $27,000 dollars. That is on top of the S&P500 dropping nearly half its value from its highs 2007. We all know how poorly the stock market has done lately and if even an S&P 500 index fund can get you twice the returns of a variable annuity then why pay for something like a complicated annuity?

Some might think that the annuity is tax protected so it would have benefits in that way. That may be true in some situations but the gains on annuities can be taxed at the full income tax rate while investing in a simple stock fund can get you the lower capital gains rate. You might come out ahead as far as taxes are concerned simply buying stocks directly. But in the case of the example they actually lost money with the variable annuity so any tax benefits of an annuity are unhelpful.

If you aren't familiar with Variable Annuities The SEC has a page on the topic of Variable Annuities with all sorts of useful information. They give a good basic explanation of what Variable Annuities are so check out that page for more if needed.

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