Markets Insight
  •  6/4/2021

Variable Annuities for Tax‑Efficient Growth

By SIMON

Variable annuities can help accumulate assets for retirement with tax deferred growth, flexible, tax-free reallocations, and death benefits for heirs.

When choosing an annuity contract, you must first determine the desired objective—growth of assets or income in retirement.  This is particularly true for variable annuities, which carry some restrictions and limitations when used to generate income.  As tax-deferred annuity contracts designed for the long term, variable annuities offer the contract owner the opportunity to participate in the performance of an underlying portfolio of funds.

In this article, we’ll explore key benefits and considerations of a variable annuity as a tax-efficient accumulation strategy, focused on delivering choice, flexibility, and protection for heirs.

Choice: Diverse Investment Options with Tax Deferral

Every variable annuity offers choice and diversity, with a multitude of different fund managers providing exposure to a wide variety of stock and fixed income funds, as well as asset classes like real estate, commodities, and alternative investments. It is not uncommon for a single variable annuity to offer over 100 different fund options from 15 or more different investment managers.  

This choice and variety is a key benefit, allowing you to build a portfolio aligned with your risk tolerance and objectives.

Tax deferral is a second key benefit to owning a variable annuity. Like every annuity, you pay no tax on any growth in your account value until you make a withdrawal. This tax deferral aspect of a variable annuity is an important feature if you are trying to accumulate money for retirement. Simply put, because the taxes are deferred, you earn interest on:

  • your original investment,
  • your earnings,
  • and the money you would have paid in taxes each year.

Eventually, you will have to pay taxes on any gains in the account.  But until that time comes, you are allowed to keep and invest those funds, thereby allowing you to grow your money efficiently.

It is important to note if you own a variable annuity within a retirement plan, such as an IRA, the annuity carries no additional tax benefits. Given the IRA itself is tax deferred, the variable annuity is taxed like any other asset within that IRA.

Flexibility: Reallocations Are Not Taxable Events

As you save money for retirement over the years your investment objectives will undoubtedly change.  Your view of the market and your risk appetite may shift as well.  A variable annuity allows you the flexibility to reallocate your money from one fund to another within the same contract, rather than sell one investment and buy another.  

A reallocation within the annuity does not create a taxable event, given no taxes are due until money is withdrawn from the contract.

This is not the case with more traditional investments—if you sell a mutual fund, stock, or bond to allocate to a new investment, gains will be taxed.  While it is not uncommon for an investor to hold onto an asset they would prefer to sell simply to avoid the capital gains tax, most financial professionals advise rebalancing a portfolio at least once per year to realign with target risk tolerance levels, resulting in short- or long-term taxable gains.  If rebalancing within a variable annuity, however, you can reallocate to a variety of different funds all within the same product, without triggering a taxable event.

Protection: For Heirs, Against a Premature Death

Most variable annuities include or offer a death benefit within the annuity contract for a fee. This benefit is designed to generate a payment to any designated beneficiaries upon the death of the annuity contract owner, so long as the death occurs prior to annuitization of the contract.

As additional protection, this benefit ensures that when an investor dies, any of his or her designated beneficiaries are guaranteed to receive no less than the premium invested.  As an example, let’s say an investor bought a variable annuity and a stock mutual fund shortly before the COVID-19 global pandemic.  In five short weeks during February and March of 2020, the S&P 500 Index fell ~30%.*  In the event of the investor’s death, the designated beneficiary(ies) of the variable annuity contract with a death benefit would receive the investor’s premium investment, adjusted for any previous withdrawals.  On the other hand, the person receiving the mutual fund investment would get the value of the investment on the day of the investor’s death, which could be higher or lower than the initial investment.  This “return of premium” death benefit within most variable annuities is particularly attractive to investors in their late 70s or early 80s, providing peace of mind when estate planning becomes more of a priority.

Some variable annuities also offer enhanced death benefits, such as one that automatically locks in a death benefit value equal to the highest account value upon any policy anniversary date.   Another type offers a specified annual percentage increase in the death benefit value. Enhanced death benefit options always incur additional costs and a financial professional should be consulted before electing this additional protection.

Things to Consider Before Buying a Variable Annuity

To recap, variable annuities can be effective, tax-efficient tools for growth if you seek:

  • Choice—of investment funds, that come with market risk
  • Flexibility—to reallocate your portfolio within a tax-deferred structure
  • Protection—to preserve a guaranteed benefit for designated beneficiaries

However, there are several important considerations to understand, including:

  • In order to provide flexibility and choice, most variable annuities offer additional features and options, which may add to the complexity and cost of the annuity.
  • Variable annuities can be an expensive way to invest relative to other investment options. While low-cost variable annuities do exist, total costs—including charges, management fees, and/or optional benefits and features—can easily exceed 3% per year.
  • Early withdrawals or surrender during the surrender charge period may trigger surrender charges, fees, or tax penalties. For this reason, an investor should be prepared and able to hold an annuity through the full length of the surrender charge period which is typically between 5-7 years.
  • Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59½, may be subject to an additional 10% federal income tax penalty.
  • Variable annuities are not FDIC-insured. All references to guarantees arising under the annuity contract, including optional benefits, are subject to the claims-paying ability of the carrier.

In order to find a variable annuity solution that can work for you, reach out to your financial professional. Carefully review a variable annuity’s offering document, disclosure document, and buyer’s guide for important contract details, including fees and charges before you invest.

Want to learn more about managing market risk with confidence? If you’re a financial professional, contact SIMON for a demo and if you’re an investor, ask your financial professional about SIMON.

You can also learn more about annuities and other risk managed solutions with articles and videos available on simon.io/engage.

©2021 SIMON Markets LLC. All Rights Reserved. | 2021.06

This is not intended to be an offer or solicitation to purchase or sell any security or to employ a specific investment strategy. This material is intended as general background information, for educational purposes only, and this material should not be used as a primary basis to make an investment decision. The materials provide a general overview of the products described, and actual financial instruments may differ materially from those described. No person should consider investing in an instrument on the basis of these materials. Any investment decision should be made only after carefully reviewing the applicable prospectus. Please remember that all instruments described in this material involve a risk of loss. This does not constitute legal, accounting or tax advice, and the recipient should consult with his or her legal, accounting or tax adviser regarding the instruments described in this material.

Prior to making any decision with respect to an annuity contract, purchasers must review, as applicable, the offering document, the disclosure document, and the Buyer’s Guide which contain detailed and additional information about the annuity. Any annuity contract is subject in its entirety is to the terms and conditions imposed by the carrier under the contract. Withdrawals or surrenders may be subject to surrender charges, and/or market value adjustments, which can reduce your contract value or the actual withdrawal amount you receive. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59½, may be subject to an additional 10% federal income tax penalty. Withdrawals reduce the account value, future annuity payments, and any guaranteed death benefits or living benefits, and can cause an investor’s contract and/or benefits to terminate without value.

Variable annuities are not FDIC-insured. All references to guarantees arising under an annuity contract, any fixed account crediting rates or annuity payout rates, and any rider guarantees, including optional benefits, are subject to the financial strength and claims-paying ability of carrier.

An investor should consider investment objectives, risks, and charges and expenses of a variable annuity and its fund options carefully before purchasing a contract and/or allocating to a fund option. Contract and fund prospectuses and, if available, summary prospectus, each contain this and other information about the applicable contract or fund, and should be read carefully before investing. The contract and fund prospectuses and if available, the summary prospectuses, are available on the applicable carrier’s website.

Securities products and services offered by SIMON Markets LLC, a broker-dealer registered with the U.S. Securities and Exchange Commission, a member of FINRA / SIPC. Annuities and insurance services provided by SIMON Annuities and Insurance Services LLC. Please visit www.simon.io for complete disclosures, including terms of use and privacy policy.

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