What the heck is an annuity part 4: Variable with Life

Posted By Paul

This is going to be my next to last posting in the annuity series (my final posting will be a collection of useful info sources I found on annuities). I'm going to talk about the most controversial member of the annuity family, the variable annuity with life.

This is a very strange investment vehicle in that it is a mix of life insurance and fund investment. Essentially you put money every month into the variable annuity, part of that payment goes into the insurance component of your account (essentially like a life insurance premium) and the other part goes into "sub accounts" (mutual funds that you can choose from a family).

So what is the appeal? Well a common argument is that you get life insurance AND a retirement vehicle. You often hear of the idea that down the road you borrow against the cash value of your annuity which means you get your money tax free. I've heard of financial advisers presenting this idea as if it were something they had thought of.

What is the downside? Here are two of the most basic arguments against variable annuities with life insurance:

1) If you want life insurance, just go and buy life insurance - my research into this mentions that generally if you compare the money you pay for life insurance through a variable annuity to just getting a normal life insurance policy you'll discover that the life insurance through the annuity is MUCH more expensive.

2) Just as with regular variable annuities, watch out for fees. Brokerage fees, fund fees, commissions, maintenance fees. They can eat up your investment quickly.

I also found in my research that when you hear about "life insurance scams" that most often it is in the form of a variable annuity with life insurance product. This doesn't surprise me since the whole variable annuity with life insurance is a great product if you want to confuse and deceive someone since you have a variable annuity (which is already a complicated and poorly defined product) and you toss in life insurance (which is a complicated thing unto itself). A variable annuity with life insurance takes these two complicated things and mashes them together into a product that is almost impossible to understand, and makes it VERY easy to hide fees.

To give a personal slant to this, I had a variable annuity/life insurance policy for a short time. I opened it and then later closed it and luckily I didn't lose much.

So what did I learn from my brush with variable annuity/life insurance policies?

-They are confusing. When I first invested I THOUGHT I knew how it all worked but only after watching it closely did I see the fees and how the affected my return on investment.

-There is inertia and psychology involved. For example when I opened my annuity I put in a small amount of money and I watched it closely. I shudder to think what would have happened if I had put my whole nest egg in there and just stopped checking it and figured it was doing fine.

-They have all kinds if little ways to keep the money rolling in. With my annuity I would get a letter every few months saying that I had been offered an increase in my life insurance death benefit, and that for just X dollars more a month I would get an additional coverage of Y dollars in death benefit. The worst part was that the letters said that unless I contacted them they would assume I wanted the increase in benefit (and premium). It got to be annoying to have to write or call them every few month and tell them NOT to raise my premium. Imagine if I had just ignored the letters? Then every few months my premium would have gone up a little and who knows where it would have ended up.

It sounds like I'm pretty down on this type of product, and I would have to say that for the most part I am.

If you read my previous article on variable annuities you may recall that I suggested going into it ASSUMING it's a bad investment and then see if you can be convinced otherwise. For the variable annuity with life insurance it's so complicated and easily prone to hidden fees and catches that I would take my warning even further.

For a variable annuity/life insurance product I would suggest the following rules:

1) If you aren't taking full advantage of 401k/Roth IRA options then don't even think of looking at this product.

2) If someone offers you an annuity life insurance product, find out what it would cost to get the equivalent death benefit with out the annuity part.

3) Take some time to find the fees. They are in there, so see where they are and how much they are, ask about broker commissions, fund fees, maintenance fees and so on.

4) Do not invest in this product unless you can get an impartial knowledgeable person to think it's a good idea. When I say impartial I mean someone who is not making or losing money based on whether or not you invest in this product. This is NOT the type of product where you should trust the person who is selling you the product.

5) Do the research. This is also NOT the type of product where you should think: "well my aunt has one and she likes it, so mine's probably okay". There is so much variety among these products that your aunt could have a totally different TYPE of product, and maybe your aunt has one but doesn't really understand how it works either.

6) If anyone suggests that you invest in this type of product, ask yourself: "Would this person make money off of my investment?" If the answer is yes, then take EVERYTHING they say with a huge grain of salt.

There might be people in situations where this type of product is a good idea, but I would predict that this type of investment is probably the most commonly owned "bad" investment.

If you are someone who has this type of product and you don't really understand it I would do some serious research into your product, just some basic things like:

1) Find out what your death benefit is and do a little research to see what it cost you to get the same benefit from a reputable insurance company without all of the annuity stuff.

2) Check your subaccounts, find out what their maintenance fees are, compare them to mutual funds at Vanguard.

If you are at all worried after doing the above, then consider finding a financial adviser that is paid by the hour and seeing what they think, or perhaps just find a trusted friend or family member that is "into investing" and have them look over the account and see what they think. The worst thing to do is to be in a bad investment and continually paying month after month.