If you've talked to a broker or agent about rolling over your retirement account, there's a good chance the advisor recommended you invest in a Variable Annuity. Don't do it! I believe the only reason a variable annuity is recommended for an IRA is so the advisor can earn more money. Let me explain.



There's a high probability that if an advisor doesn't recommend an Equity-Indexed Annuity for your IRA rollover, a Variable Annuity will be recommended instead. 'There are so many advantages to a variable annuity versus a mutual fund', you're told. I disagree. It's advantageous for the advisor, not the investor.

In this article, I'll debunk the two main arguments used in selling variable annuities. First, that you don't pay a commission and secondly, the importance of the death benefit guarantee. I'll explain how you pay dearly for both.

One of the main sales 'hooks' used in selling a variable annuity is that you don't have to pay a commission. That can be very compelling when compared to a mutual fund in which you pay the all the commission up-front. Many advisors will even say that they get compensated by the insurance company, not you. Do you really believe that?

Insurance companies are not charitable organizations. If they are paying the broker, they'll recoup those costs from you--the costs are just hidden so you don't think you're paying a commission.

The second main argument for using a variable annuity for an IRA is the death benefit (not offered with a mutual fund). "That way you'll never have to worry about your beneficiary getting less than you invested", the thoughtful advisor says. This feature may seem nice, but you end up paying through the nose for it.

With all variable annuities there is a Mortality and Risk Expense (M&E) charge. Most variable annuities sold through commission-based advisors have an M&E charge of 1.45%. This is an annual fee that is charged against the entire value of the account, not the original investment. On a $500,000 investment that amounts to $7,250 the first year. If your account doubles in 10 years, you'd pay $14,500 that year.

Note that the M&E charge is in addition to the underlying money management fees charged by the people actually making the investment decisions. Their fees can range from .70% to 1.5%. All told, the fees associated with most variable annuities range from 2-3% per year. That's a 2-3% hole you start in each year. That's $10,000-$15,000 each year on a $500,000 investment--and that expense increases as the value of the account increases.

Do you really think it costs $10,000-$15,000 a year to cover the cost of the insurance associated with the death benefit? Of course not. The full $500,000 in our example isn't really being insured, either. They're only insuring the amount of loss. So if the investment loses 10%, the actual amount of 'insurance' is $50,000. Even when the investment is worth more than you paid you continue to be charge M&E.

So the death benefit associated with a variable annuity is either the most expensive insurance you'll ever buy, or it pays for more than insurance. The M&E is where the insurance company makes their money. More importantly, the M&E is where the insurance company gets paid back the money it paid your advisor in commission. Here's proof.

The M&E on variable annuities offered by Vanguard (in which no one earns a commission) is about .60%. That's over three quarters of a percent less than the 1.45% being paid to the commission-based advisor.

The real reason that you are recommended a variable annuity for your IRA isn't that it's better for you. It's because it's better for the advisor.

If you invest $500,000 in a commission-based mutual fund, the advisor's gross commission will only be about $10,000. The same investment in a variable annuity would yield gross commission to the advisor of $30,000-$35,000 or more!

If an advisor can earn 3 times more by getting you to invest in a variable annuity instead of a mutual fund, which do you think will be recommended?