"Your June 21 article, '7 sins of variable annuities,' provides a biased, inaccurate and incomplete perspective on a product that is helping millions of Americans save for and live in retirement."

That's the opening sentence of a three-page letter from Michael P. DeGeorge, general counsel for the National Association of Variable Annuities. The discussion in his letter echoed similar communications from sales representatives around the country.

So let's talk.

While I disagree with any claim of bias or inaccuracy, I do agree that variable annuities are helping millions of Americans save for and live in retirement. The issue is efficacy. Saving in a money market account also helps millions of Americans save for and live in retirement--- but it isn't very effective. There are better ways to accomplish the same thing.

That's what I write about.

The purpose of my regular measurement of variable annuity performance vs. an index fund is simple. While the financial services community regularly makes a substantial living from its claims for superior performance and client care, the brute fact is that they charge so much for their services that most of us would be better off with a low-cost, passive, tax-efficient investment. This is why readers are likely to do better for themselves by following the Couch Potato portfolios.

The same analysis applies to variable annuities, but the results are clouded by three major claims from the sales side.

•  The first is that I ignored the value of the insurance benefits built into variable annuities--- the guarantee that your heirs will receive your original investment back, regardless of the market, if you die.

•  The second is that I ignored the additional benefit of being able to convert your investment into a guaranteed lifetime annuity.

•  The third is that I ignored the value of variable annuity contracts for creditor protection.

I ignore the death benefit guarantees built into variable annuity contracts for two reasons. First, selfish wretch that I am, I think dying is too big a price to pay to avoid market volatility. I suspect few readers are willing to die just to avoid market losses. Second, as a form of life insurance, the guaranteed death benefit is fantastically overpriced.

Suppose you are a 55-year-old man with $100,000 to invest. You want to make certain your family will get at least that $100,000 in the event of your death. If you invest in the average variable annuity, you'll pay an insurance expense of 1.37 percent a year.  This means the insurance company is charging you $1,370 a year. This isn't $100,000 of life insurance. The actual amount of life insurance is your exposure to market losses. It could be large, like the 2000-2002 bear market, but it will be less than $100,000.

If you go to www.insure.com and ask how much $100,000 of life insurance would cost for a 55-year-old average male in good health but with one parent who died of cancer, you'll find that you can buy a 10 year level term for $301, a 15 year level term for $413, a 20 year level term for $527, and a 25 year level term policy for $1,044. Women can buy the same coverage for less. Some, of course, will have to pay higher rates or won't be eligible for life insurance at all. But if you are insurable, direct life insurance is better than death benefit guarantees.

So here's a simple alternative to a variable annuity. Buy a low cost, level-premium term policy--- say a 15-year period at $413 a year. Then plunk your $100,000 into shares of the iShares S&P 500 exchange-traded fund (ticker: IVV) with an expense ratio of 0.09 percent. Your investment will have a total cost of 0.503 percent a year, including $100,000 of life insurance. Your death benefit will be a large multiple of anything you could get with the variable annuity. And your investment return will be taxed at a lower rate.

Why, you might ask, does life insurance in a variable annuity cost so much?   The answer is simple. They call it "insurance expense," but most of the money actually goes to marketing expenses. That 1.37 percent "insurance expense" works much like "B" share fees in conventional mutual funds--- it's an additional charge that helps the insurance company recoup its marketing and sales expenses. Sadly, the insurance industry avoids full disclosure.

Another benefit I overlooked is the opportunity to turn the variable annuity into a guaranteed lifetime income. It's less of an opportunity than it seems for two reasons.   First, we can convert assets into a life annuity any time we want. We don't have to buy a variable annuity to have the opportunity. If we can accumulate more money in another investment, we'll be able to turn that asset into a larger lifetime income. Since all our unrealized taxable income must be rolled into the variable annuity lifetime income, it is also possible that the tax burden on the variable annuity lifetime income will be higher than the tax burden on the independently purchased life annuity.

Second, once you are a variable annuity owner you are a near-captive customer. And the insurance company knows it. There is no guarantee the life annuity income you will be offered will be competitive with life annuities offered by other companies.

Finally, there is creditor protection.   Assets in variable annuity contracts tend to be safe from creditors and legal judgments. This can be important if you are a doctor or other professional.

Again, this is an expensive way to buy the protection that most professionals get through malpractice insurance. Other options include paying off a home mortgage and transferring assets to other family members.

Bottom line: There are simple, inexpensive, and more effective forms of insurance than variable annuities. When variable annuities become more effective tools, I hope to be the first to let everyone know.

On the web:

Term Insurance Quotes on the Web

Tilting Against Illusions, Sunday, June 19, 2005

7 Sins of Variable Annuities, Tuesday, June 21, 2005

Variable Annuity Watch (collection of previous VA columns)