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Variable annuities (VAs) are one of the most commonly misunderstood financial products.
A variable annuity is simply a savings contract with a life insurance company. The money you put inside a VA is usually money you’ve already paid taxes on. That money grows tax deferred, which means you pay no taxes on the growth until you withdraw it from the account. A variable annuity also allows you to have the money given directly to a beneficiary when you die, which saves your loved ones the hassle of going through probate court—a court that oversees wills and estates.
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Variable annuities offer many bells and whistles, such as principal guarantees and life insurance. Fees on these products vary widely.
Beware of penalties
Variable annuities carry penalties if the contract is broken prior to the agreed-upon time period, usually a declining surrender charge that lasts from six to 11 years. Also, you will pay a 10% penalty fee to the IRS if you withdraw before age 59 and a half.
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Dave’s opinion on variable annuities
So what are Dave’s suggestions about variable annuities?
- Only consider VAs when you reach Baby Step 7. You need to be debt-free, including your home, and have used all other tax-deferred options.
- Make sure you understand the fees, surrender period, and any riders or options you choose.
- Stay with the four types of mutual funds Dave suggests: growth, international, growth and income and aggressive growth.
- Never use annuities inside retirement options. There is no sense paying the annuity fee to get a tax deferment that you already have in your retirement plan. Also avoid rolling over a retirement account into a VA.
Dave doesn’t own any variable annuities, though he meets all the prerequisites. His simple investing strategy involves mutual funds and real estate. That’s it.
If you want help to better understand your investments and retirement options, speak with an investing professional near you that Dave recommends.