Q. Each time you go on a tear about variable annuities, those of us who have them feel like idiots. The question for us is can we do anything at this point to fix the situation? Can you roll an annuity over into something better or are you stuck?

---L.U., Dallas, TX (by e-mail)


A. You're not an idiot. A more accurate characterization is that you're one of the many people who have fallen victim to tax phobia and full power marketing. You are the victim of an industry that pays such large commissions that a salesman can afford to visit your house and sit in your living room until you give him a check.  

He may even tell you that it costs you nothing because the insurance company pays him. While that is technically true, it remains that the insurance company must recover its cost of marketing and distribution. The only source of recovery they have is from the return on YOUR investment.

So they reduce it.

Today, the average variable annuity sub account has a total expense of 1.96 percent a year plus an average contract charge of $45 a year. That's a major burden.

Thousands of people make the same mistake every year because they are shocked at their tax bill. They want to shelter their investment income from taxation. The prime customer for annuities is over 50 years old, the age when most people no longer have major mortgage deductions, exemptions for children, etc. At the same time, they are enjoying their maximum earning years. Their income is taxed at the highest rate they have ever seen.

The annuity marketers capitalize on the tax phobia that develops.

What investors fail to do is figure the cost of the cure. As I have shown in many columns, the annuity cure is more costly than the tax burden it defers.

The remedy for many existing annuity holders is to make a 1035 exchange to a lower cost annuity such as the one offered by Vanguard. The combination of Vanguard's low insurance costs (0.37 percent) and their low cost mutual funds, means you can get tax deferral AND money management for less than 0.60 percent a year. That's a major cost reduction.  

You can often do a 1035 exchange without cost if you have held an annuity with a declining withdrawal fee for the required number of years. Most annuities have withdrawal fee penalties that run for 5 to 7 years.

Another tack is to make the maximum penalty-free withdrawal each year, usually about 10 percent of your investment.

Sadly, there are abusive annuities that have withdrawal charges that are both long term and large. As you might suspect, they often carry the largest selling commissions. Fortunately, they are relatively few in number.


Q.   My wife and I work full time and make $130,000 a year. We have about $40,000 in debt (loans and credit cards) due to adoption costs over the last four years. We also have about $30,000 to $40,000 in equity in our house because the value has appreciated. My question is whether it makes sense to buy a larger, higher priced house with little or nothing down? We would then sell our current house, take the equity, and pay off our bills. Seems that the higher mortgage payment would be easily made without the loan and credit card payments and the interest would be tax-deductible.

But something nags at me to say that taking on MORE debt is not an answer to fix a current debt problem. What do you advise?

---R.K., by e-mail


A.   You could do this. But it is a very expensive way to pay down debt. First, you will be going through the experience of selling your house. Then you will have the expense of selling it, about 7 percent of the sale price. Then you will have the cost of moving. Now add the cost of closing on the new house, including the cost of getting a new mortgage. Finally, you'll have all the expenses of a new house move-in.

If you put a pencil to it, I'll bet you're talking about spending $20,000 so you can payoff a $40,000 debt. That's a lot to pay when no one would consider you over-extended. Financed at 9 percent for 5 years the monthly payments on $40,000 would be $830. That's less than 8 percent of your gross income.