Hello, my name is Thomas and I would like to thank Chris, Jason, and Frank for the honor of becoming a new contributing writer. I have hosted my own blog at http://personalfinancefun.wordpress.com/ since February. My frequency of postings had fallen off a little bit as my wife and I prepared to leave Alabama and head to New Mexico. My wife is an Air Force officer and I am a military dependent although I hate that terminology. In Alabama, I was working as a personal finance program manager educating and counseling Air Force members on the joys of investing and money management. Prior to Alabama, I worked in marketing for a not-for-profit association. Currently, I am working the in financial planning arena. Just like many of us InvestorGeeks, it constitutes a varied background.

Arguably, no investing product receives more bad press than variable annuities. Many individuals have horror stories to share about unscrupulous brokers who pushed them into complex annuity plans without adequately explaining fee structures and provisions. Some individuals may have thought they were getting an IRA and instead ended up in an annuity. In this article, I will explain the facts related variable annuities and give you some information to help you decide if variable annuities are right for you.

What is a Variable Annuity?
An annuity is a contract between you and a life insurance company. In return for payments, or one lump sum payment, the life insurance company agrees to provide a steady stream of income or a lump sum distribution at some future date. Many annuity plans drafted these days offer both a death benefit as well as yearly income withdrawal options. The income withdrawal options have been very popular with aging baby boomers looking to provide themselves extra income in retirement. It should be noted that your income withdrawals will be taxed at your ordinary income tax rate. If you are less that 59.5 in age, the IRS also assesses a 10% penalty.

The word variable in variable annuity refers to your original investment being invested in the stock market through sub accounts. Sub accounts are mutual funds chosen within a variable annuity contract. The annuity purchaser chooses the subaccounts they wish to invest in. The beauty of variable annuities is that if the stock market does well, your plan will “step up” to a higher death benefit or higher yearly income withdrawals. Depending on the insurance company issuing the variable annuity, you may step up yearly, or every five years.

A big advantage of variable annuities is how they let you invest tax deferred with no yearly limits like those placed on 401ks or IRAs. Unfortunately, more than half of the variable annuities sold every year are sold within tax deferred accounts like IRAs. Those individuals who bought a variable annuity through their IRA just destroyed one of the biggest advantages of choosing a variable annuity.

Another advantage is that you are also guaranteed withdrawal of no less than the principle you invested. Let us look at a scenario. Imagine you place $200K into a variable annuity with a 5% income withdrawal option. You are guaranteed to receive at least $10K per year no matter what happens to the stock market. If the market tanks, you would have the comfort knowing that the yearly income from your variable annuity would never be less than $10K although it would never step up to a higher level.

Compare this scenario to investing in an individual investing account. Imagine that you wish to take out the same $10K per year that you would have received from a variable annuity. If your investments decline by 25% for six years, your principal investment will be completely exhausted in six years. Probably not a likely scenario, but an example that shows why variable annuities are so popular amongst the risk averse.

Variable annuities also have many glaring disadvantages. You should be aware that variable annuities are a brokers best friend. Variable annuities generate broker sales commissions two to upwards of twenty times higher than sales commissions gained through the sales of mutual funds.

Variable annuities also have high fee structures compared to mutual funds. In order to provide the income guarantees and death benefits, the variable annuity provider will assess income withdrawal, mortality, expense, and administration fees. This will eat up 2-4% of your yearly investment return. These fees are in addition to the sub account fees that would have similar fee structures to that of mutual funds.

Surrender charges are another evil of variable annuities. Surrender charges are the fees you will pay to close your variable annuity. Expect surrender charges to be around 7%. The charges are assessed if you close the annuity within a specific period of time, called the surrender period. Surrender periods can vary widely, but some are as long as eight years.

Buy or Steer Clear?
My advice is to consider a variable annuity only after you have exhausted your other tax advantaged retirement options. For 2006, this means dumping $4K into your Roth or Traditional IRA and $15K into your 401K. If you elect to go with a variable annuity, conduct ample research and look for the lowest fee and no surrender charge plans.