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YOUR MONEY | MUTUAL FUNDS / RUSS WILES

Variable Annuities, the Overlooked Asset

November 10, 1996|RUSS WILES | Russ Wiles, a financial writer for the Arizona Republic, specializes in mutual funds

Variable annuities are growing faster than mutual funds, they're offering more and better investment features, and they remain one of the few tax shelters left.

But they're not making much of an impression on do-it-yourself investors.

How else can you explain the lackluster reception given to a slew of variable annuities introduced by mainstream no-load mutual fund companies in recent years?

Commission-free annuities are offered by such fund families as Vanguard, Scudder and Janus--but they account for barely 1% of the $206 billion in these products as of June 30, according to Cerulli Associates of Boston and Lipper Analytical Services of Summit, N.J.

Variable annuities now closely resemble mutual funds with life insurance, wrapped in a tax-sheltered package.

Money in an annuity grows tax-deferred until withdrawn, at which time it's taxed as ordinary income. Investors face a 10% Internal Revenue Service penalty on cash taken out before age 59 1/2. Minimum investments usually run a few thousand dollars.

When you buy an annuity, you get a choice of diversified, professionally managed investment funds. Stock portfolios are the most popular, as variable annuities are designed to be held for the long haul. Many annuity investment choices are managed by the same firms that run mutual funds.

Annuities also feature some modest benefits that investors won't receive from a fund, such as an insurance guarantee that your heirs won't receive less money than you invested (in case you die during a market slump). Most contracts now "step up," or raise, this amount every few years.

But these extra features cost money, which explains why annuity expenses exceed those on mutual funds. And without much of a challenge from no-load firms, expenses aren't likely to compress any time soon.

"Although total expenses are considered high, the industry seems under no real pressure to reduce them," says the report from Cerulli and Lipper.

Total expenses on variable annuities average 1.9%, including insurance costs for such features as the guaranteed minimum account value at death. Average costs on stock mutual funds run about 1.4% yearly.

In addition, most annuities levy back-end sales charges. In a typical arrangement, investors might pay 6% if they cashed out during the first year, 5% the next, and so on until the charge ultimately disappears.

No-load annuities don't levy such charges and some charge less for the insurance coverage.

So why aren't more investors clamoring for no-load, low-cost variable annuities?

Jeffrey Molitor, a principal at the Vanguard Group in Valley Forge, Pa., thinks the extra features on annuities make them too hard for some people to comprehend without a broker's help.

"Understanding all the costs adds another layer of complexity," he says. "We find that variable annuities are most popular among people who already own one."

Mike Brandsma, a manager in charge of the Denver-based Janus Retirement Advantage program, says many investors don't realize that they can place as much money as they want into variable annuities, even if they have already maxed out on their IRAs or retirement plans at work.

Despite their low profile, variable-annuity sales have expanded at nearly a 40% annual clip since 1988, says the Cerulli-Lipper report. That's nearly twice the growth rate of mutual funds, albeit from a much smaller base.

And new efforts could expand the market. Charles Schwab announced last week a new flexible annuity that allows investors to move money among a wide variety of investments, with few charges. "More and more customers who come to us--one in four--already have annuities," says Jeff Benton, Schwab's vice president for annuities and insurance. Schwab also plans seminars and other programs to educate new investors, he says.

Nonetheless, annuities probably will never match mutual funds in popularity. Investors can't deduct money placed inside an annuity the way they can with 401(k) plans, individual retirement accounts and the like. And the added complexities and costs are a problem.

Also, a souped-up IRA of the type now being discussed in Washington could make variable annuities in general less attractive.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

No-Load Annuities

Annuities, tax-deferred investments that include life insurance, are generally suited for a long-term investor who has already maximized the amount of money he or she is saving in a 401(k), IRA or both. Most annuities are sold with a commission, often by a financial planner, but there are also no-load products, including those below.

* Vanguard Variable Annuity, (800) 522-5555

* Scudder Horizon Plan, (800) 225-2470

* T. Rowe Price No-Load Variable, (800) 469-5304

* American Skandia Choice, (800) 628-6039

* Schwab Investment Advantage, (800) 838-0650

* WRL Freedom Bellwether, (800) 443-9975

* USAA Life Variable Annuity, (800) 531-8000

* Janus Retirement Advantage, (800) 504-4440

* Jack White Value Advantage, (800) 622-3699

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