Investing for Retirement with a 401(k) and Variable Annuities

[This question originated from a reader who read the article "Don't Put Your IRA in a Variable Annuity”]

Q. Hi, Jeff:

I like all your articles about Index Annuities.

I am about 46 years old, my annual income is around
$75,000.00. I very concern my life after retirement.
As you said I want my money stable and growth.

The following are my investment combinations, would you
please give me your suggestions:

1. I have invested $4000.00 to Roth IRA for 2005.
2. Try to invest $14,000 to my 401K (My employer
doesn't match any)
3. The rest I want to invest to Preference Plus Select
Variable Annuity, this is a new product of Metlife for
retirememt plan. The selling point of PPS is the
guaranteed-minimum rate of reture is 6%. If money
market up, you can get more (no cap but have to pay
0.5% fee).

Should I invest more into 401K plan or to other
products, such as PPS as my employer doesn't match any
dollars to my 401k.

I am looking forward your advice.
Regards,
Helen

A. That is a great question.

First, you will always want to max out the contributions to your 401(k)
instead of investing it on your own because the 401(k) money is invested before Federal taxes are taken out. In other words, there is a big tax advantage to investing in a 401(k).

I don't believe that you should invest in the MetLife PPS VA. I assume this is after-tax money and one of the things you were looking for was the tax-deferral. I am not a big believer in annuities for tax-deferral for several reasons.

First, you are only pushing the taxes down the road to be paid when you withdraw the money or die. The earnings are then taxed at ordinary income tax rates. If this is done at your death it can quickly throw you into a high tax bracket and result in 30-40% being lost to taxes. On the other hand, the gains on an investment such as an ETF or mutual fund outside of the VA will be taxed at capital gains rates that top out at 15%. Based on your income, they may be taxed at an even lower rate.

Secondly, you will have to leave the money in the VA for 20+ years before you start seeing any benefits of tax-deferral.

Third, the 6% guarantee really doesn't give you anything and it will increase your costs significantly. The fees in a VA will already be approaching 2.5-3% or more between the M&E and the subaccount management fees. There hasn't been a single 10 year period that an investment in the S&P 500 hasn't made money since the early 80's. In other words, the chance of earning less than 6% in a low-cost S&P 500 index like SPY over a 10-20 year period is extremely low. So why pay for a benefit when there is only a very small chance it will pay off.

Hope this helps. Thanks for your question.

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