Variable Annuities: Suitable?

What are variable annuities for?

Variable annuities are designed to provide:

• tax-deferred accumulation and

• future income.

Variable annuities allow the investor to select from a family of variable portfolios (similar to mutual funds) that include both equity and fixed income alternatives.

Many variable annuities usually allow annual withdrawal of a certain percentage such as 10%.

Who are Variable annuities suitable for?

•  Investors with an investment time horizon of 10 years or more that intend eventually to spend the money.

•  Investors who are active asset allocators or who prefer investments that generate high levels of ordinary income or short-term gains. They can benefit from the long-term tax deferral of a variable annuity.

•  Long-term investors who want the ability to transfer between portfolios without incurring a current tax consequence.

Some benefits of variable annuities

Variable annuities also provide other key benefits such as

• a guaranteed minimum death benefit,

• a guaranteed income base and/or

• a guaranteed lifetime income option.

These may be valuable to more risk adverse investors, but are generally not a primary consideration in the very high net worth market.

Distributions from an annuity are treated on an “earnings out first” basis and these earnings are taxed as ordinary income. (Slightly more favorable tax treatment can be obtained by converting the contract to an immediate annuity – see below.) At death, undistributed earnings are subject to income tax.

Because of the tax treatment of annuity gains, the variable annuity may not be suitable for:

•  Investors who prefer a strategy that emphasizes long-term capital gains and who are confident the tax laws will remain favorable to long-term gains during their investment period. Long-term investors, who are less confident about the current tax system remaining in place, may want to diversify their tax risk by investing a portion of their wealth in variable annuities.

•  Investors who do not intend to spend the money during their lifetime, and who will leave it to heirs subject to income tax.

*Note: Charitable beneficiaries would not be subject to tax on undistributed gains. Corporations or trusts without an individual as an income beneficiary -  These entities cannot benefit from tax deferral.

*Note: Trusts holding an annuity for the benefit of an individual does qualify for annuity tax deferral.