Variable Annuities, Where Most People Got Burned

A Variable Annuity (VA) is different from every other annuity in one big way. Your money is in the market. The insurance company creates a tax-deferred wrapper around a menu of mutual funds. You pick the funds. Your money goes up and down with the market. You take full market risk. On top of that, you pay fees. Mortality and Expense (M&E) charge. Usually 1% to 1.5% per year. This is the insurance company's overhead and profit. Investment fund fees. The mutual funds inside the annuity charge their own fees. Usually 0.5% to 1.5% per year. Rider fees. If you want an income rider or death benefit rider, add another 0.5% to 1.5% per year. Add them together and you are often paying 2.5% to 4% per year, before the market has done anything. If the market returns 8%, you keep 4% to 5%. If the market returns 0%, you lose 2.5% to 4%. This is what happened to the 69-year-old I told you about in Chapter 3. He was in a VA. It cost him roughly 2.8% a year in fees, and it lost him $66,000 in 2024 because of market losses on top of that. Why did anyone ever buy these?

Because they were sold well. In the 1990s and early 2000s, the pitch was compelling. Tax-deferred growth, income riders, death benefit protection, market participation. It sounded like the perfect product. What was left out of the pitch was the total fee load and what it does to compounding over 20 years. A 3% annual fee, over 20 years, on a starting balance of $200,000, is roughly $100,000 in lost growth compared to a low-fee alternative. Where a variable annuity still makes sense (rarely):

A high-income earner who has maxed out every other tax-deferred vehicle (401(k), IRA, HSA, backdoor Roth) and specifically needs more tax-deferred space A very specific estate-planning situation involving beneficiaries and step-up basis considerations That's a short list, and it does not apply to most people. If you own a variable annuity right now, you owe it to yourself to have it audited. Not every audit ends with a recommendation to move. Some VAs from the mid-2000s have "grandfathered" income riders that are worth more than what you could buy today. Those are worth keeping. But most VAs sold in the last 15 years have a better home for that money. Get it looked at. Section 1035 of the tax code allows you to move money from one annuity to another without triggering taxes. If the new annuity is a better fit, you can make the move without a tax bill.