A variable annuity allows you to invest among several sub accounts, which may resemble mutual funds. Inside a variable annuity, any investment income or capital gains remain untaxed. Switching among sub accounts won’t generate a tax bill.
However, variable annuities generally have higher costs than mutual funds. All income is taxed at ordinary rates when you take withdrawals, so you can’t benefit from favorable long-term capital gains rates. If you are interested, here’s what to look for:
- Wide selection. A variable annuity should offer an ample number of different subaccounts.
- Low cost. A variable annuity probably will have higher expenses than a portfolio of mutual funds, but some are less expensive than others.
Don’t buy a variable annuity if you expect to bail out soon: you’ll owe surrender fees plus a 10 percent penalty before age 59 1/2. Plan to hold on for 10 years or longer so the tax advantages are likely to outweigh the extra expenses you’ll incur as well as the lost tax advantages of long-term capital gains.
