Insurance and Taxes?

Are the best things in life guaranteed?

We all like guarantees. When I buy a new—or nearly new—car, I look to see how long the manufacturer’s guarantee runs. When we get home improvements done, we ask the builder how long he will stand behind his work. So when a life insurance company offers me an investment product guaranteed to always go up, and never to go down, it gets people to notice.

The product has been around a long time—the variable annuity. Insurance companies often will offer an account that goes up in with the stock market and is guaranteed never to decline in value. At some point you can convert your stock market exposure into a steady income stream without paying capital gains. Guaranteed market growth while reducing taxes: what’s not to like?

When it comes to annuities, plenty. Life insurance companies don’t issue these guarantees for nothing. Usually they come at the expense of limiting returns to some maximum—say, 15%. Most of the time, this doesn’t seem to matter. But a year like last year would be really expensive. With the S&P 500 up 32%, those account-holders just paid a 17% fee. It may not feel like it—because their accounts are up, too—but the cost is real.

This raises the second issue: fees. Between management costs, sales commissions, underwriting and insurance charges, annuities can cost 2-3% per year. That’s a lot more than the typical 1.5% of a mutual fund, or 10 basis points for an index fund. And those don’t charge you to get your money back. Which brings up surrender charges: if you need to get your money out of an annuity, there’s often a back-end fee—unless you withdraw it bit-by-bit. And there can be tax penalties as well, if you do this before you’re old enough.

There are no guarantees in life—someone has to pay. Insurance can help you reduce taxes and provide financial security to your loved ones, but it’s an expensive way to manage money. If something looks too good to be true, it probably is.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2014-03-11T09:35:03+00:00 March 11th, 2014|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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