Does Your Tax Shelter Leak?

CONSIDER THESE FACTORS

Costs associated with variable annuities can be high due to the features and options involved, so before you buy any, evaluate the following features against competitive proposals:

OPTIONS FOR BENEFICIARIES

An additional benefit of variable annuities is that numerous options are available. These are as follows:

Unless the stretch-out options, which provide the longest possible payout to a beneficiary, are offered with variable investment continuing to the beneficiary, tax loss by the beneficiary is the biggest booby trap in this investment vehicle, as it has been with traditional IRAs prior to the new 2001 changes in the regulations. This is because all payments from a variable annuity are ordinary income, regrettably, and subject to the appropriate income tax.

CHOOSING AN ANNUITY

From my experience, the no-load variable annuity offered by Charles Schwab & Co. and discount broker T.D. Waterhouse (formerly Jack C. White Co.) and the front-end load annuity by Nationwide Insurance's "Best of America IV" best meet the criteria I have outlined. One investment manager produced these results:

With these kinds of investment results, a variable annuity contract starting with $50,000 and 18% ARR would double every four years.

CONCLUSION

Unfortunately, a financial advisor or planner only has to say "tax-free" and too many people simply reply, "Where do I sign up?" Variable universal life insurance owned by an irrevocable trust is the only estate and income tax%ADfree equity or stock investment vehicle available. (For other articles on variable life insurance, visit www.working-money.)

Variable annuities do offer advantages such as tax-deferred earnings, professional management, and flexible payout options. Above all, before jumping into a variable annuity, be aware of all the costs and beneficiary options.

Morley Hudson is a mechanical engineer and former Louisiana State Representative. He is a retired estate executor, trust manager, and investment manager.

SUGGESTED READING

Hudson, Morley [2001]. "Shake Uncle Sam Off Your Coffin," Working Money, Volume 2: May.

VARIABLE ANNUITY OPTIONS FOR WITHDRAWALS PRIOR TO AGE 59-1/2
AND FOR BENEFICIARY AFTER DEATH OF ANNUITANT/OWNER

Systematic withdrawals prior to age 59-1/2 are normally subject to a 10% penalty tax except if substantial, equal periodic payments are taken. Thus, payments must be made at least annually, continue for at least five years or until the recipient reaches age 59-1/2, and assume no more than a "reasonable" level of interest or investment return.

Any company will supply a printed payout schedule on these withdrawals. Here's an example showing payout schedules for a $140,000 contract for two individuals. They are based on 0% and 5% interest but could be any interest rate between 0% and 9%.

Nancy: Age: 51
0% provides $5,166 annually
5% provides $9,089 annually

Courtney: Age: 42
0% provides $4,005 annually
5% provides $8,146 annually

The variable investment feature would continue during this systematic withdrawal time interval.

When the annuitant/owner dies, the beneficiary has these options:

Full lump-sum death benefit

Five-year payout of death benefit

Annuitization

The life annuity is paid during the lifetime of the beneficiary, but with his/her/their premature death, the remaining value of the contract goes to the insurance company.

A life annuity with 10- or 20-year payments guaranteed or certain means that payments would continue beyond any premature death of the beneficiary (that is, less than life expectancy) to his/her named beneficiary.

None of the annuity options can exceed the life expectancy of the beneficiary at his or her age during the year the annuitant and/or owner dies.

Some insurance companies offer the option of either a fixed (specific interest rate) or variable (investing in the stable of mutual funds) payout to the beneficiary. Unfortunately, many only offer the fixed payout. One of the largest insurance companies reverts from the variable investment to the fixed as soon as the annuitant or owner dies; other insurance companies do this when the annuitant selects an annuity option or annuitizes. Run, do not walk, away from this type of policy.

Be aware that many life insurance companies change from the variable investment method to the fixed interest rate investment option, regardless of what you selected. It is critical to get this information confirmed in writing by the death benefit or payout department of the insurance company. Make sure the statement is countersigned by an officer of the company. So far, two companies have changed their tune and not backed their representatives' statements at the customer relations level.

When the annuitant (or owner in some contracts) dies, the key questions to be addressed are:

If either or both are in the negative, then consider transferring to another variable annuity contract with an insurance company that offers policies that answer positively to both questions.-M.H.

Copyright © 2001 Technical Analysis, Inc. All rights reserved.