Some planners recommend them; others think that's malpractice.

The field of finance abounds with controversies, but few engender such heated debate as the question of whether it's appropriate to use annuities in IRAs and other qualified accounts. Not too surprisingly, those who find favor with this practice are often the ones selling annuities, although planners of all compensation stripes will take the other side of the debate.

Before exploring the different sides of this complex issue, let's give it some structure. Any discussion of annuities has at least four dimensions to it. There are fixed annuities and variable annuities; they have an accumulation and a distribution phase; there are tax effects to consider; and there is the issue of timing their purchase.

How about cost? Yes, cost may be an issue, but a more controllable one. While certain annuities can be very costly, a fee-only or otherwise client-centered planner can find low-cost annuities from companies like Vanguard or Aegon, among others, if he tries hard enough.

Even annuities that seemingly pose a high cost may not really do so when compared with alternative investments, says Richard Hall, an Albuquerque, N.M., fee-and-commission planner. "If you use a load fund, your client will pay 5.75% up front and a .25% or higher 12(b)1 annual cost ... or, if you use C shares, a 1% to 1.5% 12(b)1 trail. If you're an assets-under-management guy, you'll charge 1% to 1.5% per year. The annuity I use has a 1.15% annual M&E and admin fee, and a seven-year declining surrender charge that is only relevant if the client takes out more than 10% per year. So, on an annual cost basis, it appears the annuity is equivalent to either load mutual funds or no-loads in an AUM [assets under management] program."

Putting aside the issue of cost, many planners still make up their minds about annuities in IRAs based upon maybe two of our four dimensions, but seldom the complete picture. If we instead consider all four dimensions, it's possible to make a more educated decision for our clients.

Let's start with fixed annuities. By using the "fixed vs. variable" dimension as the pivot-point of our analysis, we can more easily discuss the realities of accumulation vs. distribution, tax effect and timing on the decision to invest in annuities for our client.

Fixed Annuities

Are fixed annuities appropriately bought for a retirement-age client in his IRA or qualified plan? At certain times, they just may be, says Kathleen Cotton. Cotton is the owner of Cotton Financial Advisors Inc. in Lynnwood, Wash., and a fee-only planner who, she says, "sold tons of fixed annuities back in my broker days."

"The fixed annuities that I placed in IRAs were put there for their value as an investment vehicle, not for their tax deferral," she says. "It was not uncommon to find annuities paying more than bank CDs or bonds. Renewal rates on such annuities were good in that they paid the same rate on renewals as they did for new annuity contracts. This meant they kept their slightly superior yield position over time. Because a fixed annuity has no internal expense, my clients realized the stated rate."

Does the annuitization of an existing fixed annuity, or the purchase of an immediate fixed annuity for retirement income, make sense? F. Dennis De Stefano, owner of De Stefano Wealth Management in Maui, Hawaii, thinks not. "If a fixed annuity is used to provide a lifetime income, then your client has acquired an investment guaranteed to go down in value each and every year as inflation erodes the purchasing power of the income stream," he says.

How about the tax effect? So many planners, like Carol Wilson, for example, feel that a tax-deferred vehicle has no place in an IRA or qualified plan that is, in itself, tax advantaged. Says Wilson, owner of Salt Lake City, Utah's Wilson Financial Advisors Inc., "I am an insurance consultant for the state of Utah, and whenever I see an annuity inside a tax deferred vehicle, I discuss with the client the high cost of having this annuity there in the accumulation phase." Echoes Warren McIntyre with VisionQuest Financial Planning in Troy, Mich., "Annuities are sold because the 'advisor' makes the most money on this product." In which case, adds McIntyre, is the seller really going to avoid the huge IRA market just because it's the right thing to do? "Of course not," he says.

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