by Archie M. Richards, Jr., CFP^®
December 12, 2005

Allen writes, "My wife, 35, made $55,000 this year as a real estate agent, her best year ever. Our accountant said she needed a retirement plan with tax advantages and recommended a MetLife variable annuity. I couldn't make heads or tales out of the pamphlet he gave us. What's your opinion?"

Nice going to your wife, Allen, but I don't like the accountant's recommendation one bit. Accounting organizations made a big mistake when they authorized accountants to sell investments. The conflict of interest is too great.

Whenever you receive an incomprehensible pamphlet about any investment, it's probably a bum deal.

Okay, let's start with your income taxes. They may be lower than you think: Assume that you and your wife jointly make $100,000. Knock off $15,000 for exemptions and deductions, leaving $85,000 taxable income. Your federal tax comes to $14,580.

That's 14.6 percent of $100,000. Isn't this less than you would have guessed?

Many people think of the federal tax rate being 28 percent. But the first dollars earned are taxed at much lower rates. The effective rate on all of your taxable income is only 14.6 percent, leaving you with more than 85 percent of your income.

The MetLife variable annuity won't save any of those taxes - not one penny! Annuities prevent the money earned within the account from being currently taxed. But the money contributed to the annuity is not deductible.

Only if you submerge the annuity within a traditional IRA is income tax saved. The annuity doesn't save the tax. The IRA does, all by itself.

The IRA also protects earnings generated within the IRA from current taxation, just as does the annuity. You're buying two vehicles, one within the other. Both provide the same things.

But both have costs - especially the annuity.

The IRA gives you a deduction for the money contributed, plus protection from taxation of the income earned in the account. For these purposes, the annuity is unnecessary.

The annuity does provide certain guarantees against market losses, which an IRA does not. But those guarantees have nothing to do with saving taxes. The guarantees, furthermore, are not as encompassing as most people think.

Annuities have high operating costs - at least 2.5 percent a year. If the market gains 10 percent a year, you're paying out at least a quarter of it in costs. That's a higher percentage than your current income-tax burden!

If you're reading my column regularly, what do you need market guarantees for? Both you and your wife should open IRAs with Vanguard and buy a broad selection of index funds. Your total annual costs would probably come to 0.20 percent. The costs of the annuity are at least 12 times higher!

Even better, pay the darn 14.6-percent tax and put the funds in Roth IRAs. You don't get a deduction up front, but the money is never taxed thereafter, even when it's withdrawn.

In any event, forget the variable annuity.

Margaret writes, "I like two stocks, one priced at $82 a share and the other at $18. I can only pick one. Is the lower-priced stock a better value?

No, Margaret; it isn't.

Let's say both stocks are priced at 20 times earnings, with the dividend yield and growth prospects the same.

Under these circumstances, the two stocks theoretically have exactly the same value. (On a percentage basis, the lower-priced one is probably more volatile.)

But the higher-priced stock may be a little better buy. Uninformed investors assume wrongly that lower-priced stocks are more desirable.

They're not. They just enable the purchase of more shares, which means nothing in terms of the growth potential. Don't look for price returns; look for percentage returns.

Since many people prefer lower-priced stocks, they have to pay up for them. All other things being equal, I therefore suggest buying the higher-priced stock. Its price is probably lower in terms of the growth potential. Plus, on a percentage bases, the up-and-down fluctuations will be less.