by Archie M. Richards, Jr., CFP^®
February 7, 2005

Luanne writes that she and her husband, ages 64 and 69, have $200,000 in IRAs, invested in Vanguard and Fidelity mutual funds. They're considering moving the IRA to the variable annuity of a prominent insurance company which guarantees a return of at least 5 percent. (Luanne mentioned the name of the insurance company, and I reviewed the prospectus.)

Most of the guarantee won't apply to you, Luanne. The guarantee doesn't take effect until you've held the policy for 10 years. But you and your husband must begin making distributions from your IRAs at age 70½. For your husband, that's two years from now. For you, six years. Until the 10th anniversary of your policy, no guarantee applies. But you nevertheless must pay an extra fee of 0.5 percent per year from the beginning.

The guarantee doesn't apply until the policy is also annuitized. Only 1 percent of annuity policies are annuitized. If you're not part of the one percent, you'll pay the extra fees for nothing.

Moreover, it's unwise to invest IRA money in any kind of annuity. The annuity delays taxation, true, but the IRA you already have does the same. Why incur extra costs to obtain a tax advantage you already possess?

Did the salesman emphasize these matters to you? In your email to me, your unqualified focus on the guarantee indicates that he did not.

The variable annuity has other problems: Parts of the prospectus, especially the explanation of the guarantee, were incomprehensible to me. If they aren't clear to you, you have to depend on the salesman to explain. All salesmen stress good points and skip lightly over the bad. But insurance salesmen are especially guilty of this. With their commissions so high, they have a lot at stake in making the sale.

Are you aware that if you invest the entire $200,000 in the variable annuity, the salesman and the organization he works for will earn at least $14,000? This is money you and your husband can keep for yourselves if you stay where you are.

Prospectuses for all annuities don't specify how much the sales people receive. The policy's fees are explained, but not the payments to the sales force - an unfortunate omission.

Also, the commission rates for annuities stay the same (probably 7 percent) no matter how large the investment. This contrasts with mutual funds sold by salesmen. Their commission rates fall as the amount of investment rises. The Vanguard and Fidelity funds you already own pay no commissions at all.

The salesman may have told you "No commission is charged. All your money goes to work in the investments you choose."

This is technically correct. But the annuity incurs fees that are at least 2 percent higher each year than you're paying now. Plus, if you pull out a substantial portion of the money in the early years, you're charged a redemption fee. Starting at 7-to-9 percent, the percentage drops to zero over 7 or 8 years. Portions of all these charges reimburse the insurance company for the commissions it paid up front.

I dislike the way insurance products are sold. Consumers are fooled all too often.

Despite the above, I must add that insurance companies fulfill a vital function in the economy. The premiums they collect provide enormous amounts of capital to finance business enterprises. Since premiums continue for long periods, insurance companies can make long-term investments and loans.

Some business projects require long incubation periods before they turn profitable. Without insurance companies to provide the capital, some of those projects wouldn't get started, and the people who work on them wouldn't be hired.

But it's a shame that insurance companies can't provide the same benefits without taking advantage of their customers.

If you're dodging creditors and living paycheck to paycheck, HomeEconomiser (homeeconomiser.com) suggests you consider going without cable TV, daily newspapers, bottled water, water cooler, spas, acrylic nails, magazine subscriptions, health club membership, first showings of movies, lunch out every day, and season tickets to sports events.

These things are fine if you have the scratch to pay for them. But food, clothing, and shelter come first - preferably with little or no debt.