Variable annuities are basically contracts between a life insurance company and an individual, allowing the individual to invest on a tax-deferred basis and to choose from among the available mutual fund portfolios.

Baby boomers are now becoming aware of variable annuities as a potential retirement planning tool.

The first wave of baby boomers — the largest generation in U.S. history — is comprised of individuals now past 50. Baby boomers are beginning to enter their “pre-retirement” years, a milestone that highlights the importance of planning for retirement.

However, significant numbers within the baby boomer generation have put off or simply ignored saving for retirement. Furthermore, Social Security and pension plans will not fully meet their retirement needs when they’re 65.

Together, these plans will probably provide less than half of the approximately 75% of pre-retirement income baby boomers will need to maintain their present standard of living in retirement.



The Challenge

The retirement challenges boomers face are greater than those faced by prior generations. In order to preserve their present lifestyle in retirement, late-starting savers are going to have to put aside more money and accumulate retirement dollars faster. Some of the reasons:

  • Boomers will need more money than their predecessors to support longer lives. Better health practices and advances in medicine point to more people enjoying a longer, more active retirement.

  • Social Security will only provide approximately 18% of boomers’ retirement income, according to the Social Security Administration, and, beginning in 1994, up to 85% of Social Security benefits may be taxed. For the younger boomers (born after 1960), the Social Security retirement age is scheduled to reach 67, and may go higher.

  • Company-sponsored defined benefit pension plans may be scaled back and fewer employees may qualify for them. Instead, more and more, the focus is likely to be on company-sponsored defined contribution plans, such as 401Ks, that offer employees the opportunity to contribute a portion of their income to save for retirement. With defined contribution plans, the onus to fund the plan for retirement rests with the employee, not the employer.

  • Retirement will cost more. In addition to inflation, health care costs have been rising steadily, and boomers are likely to receive less Medicare funds than earlier generations.



    • Some Good News

    Though their preparation is lagging, the good news is that, with the proper planning, many in this group can make a comfortable retirement a reality. Not only are today’s baby boomers entering their peak earning years, but many are part of two-income families, which often signifies a large discretionary income.

    This potential for savings, combined with a strong desire for a comfortable lifestyle, should encourage boomers to put aside more funds during these high-income pre-retirement years. In addition, this generation still has time to select long-term investment vehicles, such as stocks, that have the potential for growth and appreciation over time.



    The Role of Variable Annuities

    The pre-retirement situation of boomers demands that they invest differently from their predecessors. They will need retirement programs that seek to minimize risk while maximizing returns. In addition, boomers will seek programs with features that make investing flexible and convenient. Given these factors and objectives, variable annuities may be an excellent investment consideration.

    Variable annuities allow an investor a choice of mutual fund portfolios. Each of the portfolios is developed around a set objective (aggressive growth, global investment, or income preservation, to name a few) to meet the diverse needs of investors. Value of the annuity fluctuates with the performance of the investments the individual chooses.

    For those investing for retirement, variable annuities provide:

  • Growth opportunities through a range of professionally managed investment portfolios;

  • Tax advantages (Assets held in a variable annuity grow on a tax-deferred basis during the initial “accumulation period,” allowing money normally paid as current taxes to compound and grow. Applicable taxes are due on earnings upon withdrawal. A 10% penalty may be incurred on withdrawals of earnings prior to age 59 1/2.);

  • Liquidity (Depending on the plan selected, variable annuities may provide some access to money free of company-imposed charges. Withdrawals of earnings are subject to ordinary income taxes and, if withdrawn prior to age 59 1/2, may also be subject to a 10% Federal income tax penalty.)

  • Value-added features, such as automatic additions and automatic dollar cost averaging; and

  • Beneficiary protection through a guaranteed death benefit. (Payment of a guaranteed death benefit is dependent on the claims paying ability of the insurance company.)

    • When considering variable annuities, investors should read the product prospectus carefully prior to investing or sending money.

    Toal is a financial advisor with Morgan Stanley Dean Witter. He can be reached at 800-488-4380.

    Publication date: 09/11/2000