Variable Annuities: Estate Planning Saboteurs

As a wealth preservation attorney, my practice involves various areas of the law including investment portfolio analysis, asset protection, risk management and estate planning. Three primary wealth saboteurs are investment portfolio mismanagement, tax erosion, and personal liability exposure.

I recently read a story indicating that sales of variable annuities have significantly increased. As I wrote in an earlier post, a key question that every investor should always ask before making any investment is “why?”

That question certainly applies with variable annuities. Variable annuities usually involve two of the three risk saboteurs-portfolio mismanagement and tax erosion. Variable annuities can completely destroy an investor’s estate plan.

Variable Annuities and Tax-Deferred Growth
People usually say that they invested in a variable annuity for opportunity for tax-deferred growth. What they fail to realize is that there are other less destructive means of obtaining tax-deferred growth.

Individual retirement accounts (IRAs) are one source of tax-deferred growth without the excessive costs and restrictions associated with variable annuities. IRAs also allow investors to choose their own cost-efficient investment options, allowing investors to avoid the overpriced and poorly performing investment options usually selected for variable annuities.

With most variable annuities typically have a minimum combined cost of 3 percent or more annually, investors should remember that each additional 1 percent of annual fees and costs of an investment reduces an investor’s end-return by approximately 17 percent over twenty years. That could result in an investor losing more than half of their end-return due to a variable annuity’s fees and costs alone, especially if the annuity owner invests in one of the so-called “living benefit” riders often pitched to prospective variable annuity purchasers.

Variable Annuities and Tax-Erosion
Investors often fail to recognize the difference between tax-deferred and tax-free. Tax-deferred means that at some point, somebody is going to be required to pay taxes on an investment. Tax-free means just that, no tax will ever be required to be paid.

When taxes are paid on gains in a variable annuity, those gain are generally taxed as ordinary income. Tax rates on ordinary income gains are always higher that tax rates on so-called “capital gains.” Explaining capital gains is beyond the scope of this article. Capital gains are generally based on the nature of the investment and/or the length of time an investment has been held by an investor. The takeaway here-capital gains are generally preferred over ordinary income due to lower tax rates.

Two mistakes I constantly see are people putting investments that are already tax-advantaged into tax-advantaged accounts. 401(k)/403(b) accounts and IRAs already provide tax-deferral to investors. So why would anyone buy a variable annuity and put the annuity inside a 401(k)/403(b or IRA account?

The same goes for investing in investments that may qualify for capital gains treatment or pay out capital gains income, e.g., stock and equity mutual funds, inside a variable annuity. All that does is convert capital gains into ordinary income for tax purposes, resulting in higher taxes. A general rule of thumb is to place tax-inefficient investments, into tax-deferred account, thereby deferring taxation of otherwise immediately taxable income.

Another general rule of thumb is to place tax-efficient investment in regular investment accounts to take advantage of any favorable tax options, i.e., capital gains and qualify for a stepped-up basis once the investment owner dies. Variable annuities do not generally qualify for a stepped-up basis once the owner of the annuity dies. This is why variable annuities can effectively destroy an estate plan.

Variable Annuities and Loss of Life Savings
Variable annuities are often pitched with the line that investor will never lose their original investment. Furthermore, a variable annuity owner will never run out of money because they can always annuitize their variable annuity and receive payments based on their original investment and the method they chose when they bought the annuity.

What annuity ads do not mention is that if you annuitize a variable annuity, you lose total control over the value of the annuity. Upon the death of the variable annuity owner or designated annuitant, the balance remaining in the variable annuity goes to the company that issued the variable annuity, typically an insurance company not to the variable annuity owner’s family of other designated beneficiaries.

I doubt very few people would say that they worked all their life just so they can benefit an insurance company. But that’s essentially what variable annuity are, a bet by variable annuity issuer that the annuity owner will annuitize and die before depleting the value within the variable annuity, the sooner the better so they receive greater value.

The Beloved Death Benefit Scam
Anyone being pitched a variable annuity will undoubtedly hear that variable annuities offer a death benefit which ensures that when they die, assuming that they have not annuitized the variable annuity, their designated beneficiaries will receive no less that their invested principle.

Moshe Milevsky, a well-respected expert on variable annuities, exposed the death benefit scam by disclosing that variable annuity issuers were generally charging variable annuity owners an annual expense fee that was ten times the actual inherent value of the annuity’s death benefit. While fees naturally vary between variable annuities, the excessive overcharge issue remains. Google “Moshe Milevsky The Titanic Option” to read the article online.

Due to the historic patterns of the stock market, it is extremely unlikely that a variable annuity owner would ever need to available themselves of the death benefit, leading one of colleagues to utter the best analysis of the death benefit in variable annuities:

A variable annuity owner needs the death benefit like a duck needs a canoe paddle.


Two takeaways that anyone considering purchasing a variable annuity should remember. The first is a well-known saying in the investment industry-“annuities are sold, not purchased.” The second comes from an article I recently reading read at a web site entitled “The Balance” (

Annuities are a form of insurance, and insurance is a risk management tool—not an investment… For investing purposes, index funds are often a better choice than a variable annuity. For the purpose of a guaranteed outcome, other types of annuities are better. That doesn’t leave many situations where a variable annuity is a smart choice.

Variable annuities can easily destroy a well-done estate plan. As the referenced quote points out, there are other viable and more sensible options for achieving the same goals without destroying one’s estate plan and possibly providing nothing for one’s family and heirs.

For those interested in an analysis of the sales pitches variable annuity salesmen often use, click here.

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This article is neither designed nor intended to provide legal, investment, or other professional advice as such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

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