Q. I have invested in a variable annuity through Fidelity for my 11 year old daughter. The reason I have done this is that I feel pensions won’t exist 50 years from now, when she will be eligible to withdraw from the annuity. I started this annuity for her when she was 8. It currently has about $20,000 dollars in it. The money in the annuity is almost 100 percent contributions. It did show gains until the crash. I also have about $9,000 in a fund with T. Rowe Price that mirrors the S&P 500.

The annuity with Fidelity is in four subaccounts. Most of the money is in a Fidelity Funds Manager fund with an expense ratio of 0.94 percent. It also has Fidelity Real Estate, which has an expense ratio of 0.90 percent; Lazard Retirement Emerging Markets Debt, which has an expense ratio of 1.3 percent; and Morgan Stanley Emerging Markets Equity which has an expense ratio of 1.60 percent.

I can contribute $300 to $400 a month. I have other ways to fund her college (529, cash, etc.), her car and housing.

My question ONLY concerns her pension fund. Should I stick with the annuity, or go with the index fund? —J.R., by email

A. When you are trying to think that far ahead, it’s good to think about the consequences of a period of time that long— basically, you’re talking about a period of at least 50 years.

The first reality is that each of the managed funds you own will likely have 7 or more different managers over that period. While one of them may be able to provide superior performance, it’s a virtual certainty that most won’t. Add the hefty additional expenses you are paying for management and it is nearly certain that the gains in each fund will be below an index fund in the same category.

So what you need is a low cost variable annuity built to hold index funds. Fidelity offers the low cost variable annuity part. In September, Fidelity reduced the insurance expense on its variable annuity from 35 basis points to 25 basis points (There are 100 basis points in 1 percentage point.). This is a fraction of what most variable annuities charge. The difference, which is about 1 percentage point a year, makes the Fidelity product a great choice for 1035 exchanges from other variable annuities with high insurance charges.

Unfortunately, Fidelity doesn’t have the second part— low cost index funds to put inside the annuity wrapper. The least expensive of your choices is just under 1 percent a year. Since you know that management choices will be meaningless over such a long period, you also need a product with as many low cost index funds as possible.

You can get that from Vanguard. Their variable annuity has insurance expenses of 0.19 percent and an account expense of 0.10 percent— in the same league as Fidelity. They don’t offer a wide variety of index funds, but the expense ratios on all their funds are low. Put it all together and your total annual expenses will average about 0.60 percent. This is about half of what you’ll pay, all-in, for the Fidelity annuity if you choose their lowest-cost funds. Fidelity, in turn, is about half the all-in cost of a typical variable annuity.

Now let’s see the difference over 50 years. A $10,000 investment in a portfolio with an expected return before fees of 8 percent will accumulate to:

  • $354,988 after expenses of 0.6 percent in the Vanguard variable annuity;
  • $268,264 after expenses of 1.20 percent in the Fidelity variable annuity,
  • $152,474 after expenses of 2.4 percent in a typical variable annuity sold by a commissioned sales person.

I don’t think you need to ponder too long which will be the best choice for your daughter. The differences here are probably the reason Albert Einstein once declared compound interest the 8th wonder of the world.

It’s also a good thing you don’t have all of the money in a variable annuity. Remember, you can’t withdraw money from these accounts before age 59 ½ without paying a penalty. So it’s a smart idea to have some additional money put aside in a tax-efficient and low cost index fund. Here, you would do best with an exchange traded fund such as the Vanguard Total Stock Market Index ETF (ticker: VTI, expense ratio 0.07 percent) or the Schwab U.S. Broad Market Index ETF (ticker: SCHB, expense ratio 0.06 percent).