INVESTING: Annuities have a bad reputation, but some are golden

The concept of an annuity has been around a few thousand years. Wealthy Roman citizens would often establish these longterm income streams for their children so they wouldn’t have to work.

The tradition carried through to the British Empire, as rich parents crafted plans to take care of their spoiled kids. Annuities are popular in America today, although the reasons are somewhat different.

For a long time, the IRS has treated the deposit of funds into an insurance company as a tax shelter. Remember a few weeks ago I was going to reveal the last true shelter in America? This is it.

Americans don’t use annuities as much to take care of their kids as they do to avoid paying taxes. It works like this: You buy an annuity from an insurance company. The money grows tax-free. You pay income taxes on the gains you make when you take money out of the annuity. It works like a 401(k) plan, except there is no annual limit to how much you can put into an annuity.

There are two kinds of annuities, fixed and variable. If you buy a fixed annuity, the insurance company will usually guarantee a fixed rate of return for a certain number of years, usually 7 percent.

With a variable annuity, it’s up to the buyer to trade mutual funds in order to grow the money. Insurance companies may offer return guarantees of variable products, but they will charge you for that.

Personally, I love variable annuities. These products have a terrible reputation in the market and a lot of it is probably well-deserved. The insurance companies took a great thing and abused it, and the consumer reacted appropriately by shunning the products. (See, we don’t need regulators to protect us. The market works if you let it!)

Too many of the products lock up the buyer for up to eight years so the insurance company can pay the agent an absurd commission. Then, the companies layer on high annual fees.

Despite these blatant abuses, a few insurance companies offer incredible variable annuities that make sense for almost anyone. Jefferson National leads the pack with a zero lockup and a flat $20-a-month fee, regardless of the size of the annuity.

American Skandia offers a few products that charge only 60 to 65 basis points a year, and give the buyer choices regarding what they can do with the annuity. Both of these companies allow daily trading in dozens of mutual funds, including Rydex and Profunds. I love these because Rydex and Profunds offer funds that can profit from just about anything the market will do, as long as you are positioned correctly.

As long as you trade the account right, you can grow it for 20 years or more without paying taxes on gains. You only pay when you take money out of the annuity. (I trade both Jefferson National and Skandia annuities for clients.)

The tax advantages of annuities make them attractive, but the ability to both long and short the market makes them a slam dunk. The next several years are apt to be like the last several, a lot of noise without much net movement. Investors who seek flexibility are going to be the ones who hit that elusive goal of consistent performance.