Every now and then, I see an article that slams an entire industry or writes off an entire line of products without examining the potential benefits from every possible angle.

Earlier this week, MSN Money’s Personal Finance section published an article basically dismissing variable annuities as a whole.

I couldn’t agree more that the variable annuities business is, by in large, a profit-laden industry with overpriced expense ratios, confusing regulations, and a myriad of other issues.  However, I don’t think that is sufficient justification for writing off the entire industry with the “don’t bother” tone the article projects.

As someone who enjoys searching for the infamous needle in the haystack, I took this as somewhat of a challenge to find one situation where someone might actually benefit from a variable annuity.

Guess what?  I found one!

Who could benefit from a low cost variable annuity?

Let’s say you’re the stereotypical young professional who regularly contributes to your employer sponsored retirement account (401k, 403b) and maxes out your yearly IRA contribution (Roth or Traditional) each year.  The majority of your finances are in good working order, with little to no debt and adequate savings stashed away for a rainy day.

Then, life takes an unfortunate turn.  You find out that a close family member passes away, but was kind enough to include you in their will.

You suddenly have a $75,000 check showing up at your door a week later!  Who’s loving old Uncle Charlie now?  Right?

Such random things do happen more often than you would think, and will likely become more commonplace considering the number of baby boomers nearing retirement age.  Ramit at I Will Teach You To Be Rich and Free Money Finance have recently described two such situations here and here.

Why would you consider a variable annuity?

1. You’ve maxed out your 401k/403b employer sponsored plan and your IRA.  This is a pretty tough criterion to meet for most people.  If you can’t meet this requirement, a variable annuity is probably not for you.
2. You do not need this unexpected cash for any short or medium term goals.  If you have a good job, steady cash flow coming in, and have very little debts, chances are you don’t need to use this unexpected bonus.  Perhaps if you were starting a business, buying a home or starting a family, that would be a sufficient reason to keep this money in a liquid savings account until it was needed.
3. You believe you will fall to a lower tax bracket once you enter retirement.  Taxes on variable annuities are paid only after they are withdrawn, just like your 401k/403b plan.  However, taxes are only paid on the profits you make, and not on the initial capital you invest.  In this case, you would only pay taxes on any gains over $75,000.
4. You want another tax deferred account to fund your retirement. This is likely the biggest advantage to variable annuities because they offer tax deferred growth unlike a regular brokerage account.  Over time, it is widely proven tax deferred accounts appreciate at a much faster rate (see graph below).

Graphic taken from Vanguard’s Variable Annuity brochure.  Assumes a 28% tax bracket with an 8% ROI.

What low cost variable annuities are readily available?

If you are familiar with Vanguard (a name you will hear repeatedly on this blog), you likely know about their ultra low expense ratios for mutual funds and exchange traded funds (ETFs) compared to industry peers.

Not surprisingly, Vanguard also has an attractive variable annuity package offered at shockingly low rates compared to the industry average.  According to Morningstar, the average Vanguard Variable Annuity has a cost of 0.57% versus an industry average of 2.37%… that’s a 76% discount from their competitors.

Didn’t I say something about a needle in a haystack?

If a variable annuity is something you are considering, do the basic research first.  Run through the above criteria and determine if the income used to fund that annuity (whether it would be fixed or variable) will not be needed until you begin your retirement.

However, I can’t stress strongly enough the importance of picking up the phone and call an expert.  Missed opportunities or omitting an important step in this process can have serious implications for your future retirement, so use an expert whenever possible.

Disclosure:  I have no affiliation with Vanguard nor am I being reimbursed for the endorsement in this article.  I’m just a satisfied customer.

Photo by Ram @ Flickr.

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