Annuities have never been flashy. Respectable -- yes. Consistent -- absolutely. And solid -- without a doubt. But flashy -- no.
Now, however, there is a new look to the annuity market. William Clemmer, national marketing manager for Massachusetts Financial Services/Nationwide Spectrum Annuity, says, "People are talking about them now."
Spectrum, a no-load variable annuity fund, has seen its assets move from $11 million in 1978 to $55 million the next year, and up to $250 million in 1980. Why this interest in the annuity?
Like the insurance companies that set them up, annuities have always dealt in the long rather than the short run. They keep a cautious eye fixed on the future.
Their most attractive feature is their tax-deferred status. Income earned from investment in an annuity -- whether fixed or variable -- is not taxable, so long as it remains invested in the annuity. Someday, way down the road -- maybe at retirement time or when children approach college age --cash may be required. At that time, an original investment of after-tax dollars can be withdrawn, tax exempt.
When the earnings are withdrawn, they are taxable. But the bonus is this: For years interest has been accruing tax free rather than being tapped by the IRS.
So there it is -- a good, albeit conservative, method of creating a nest egg. Since its inception in the 1950s, it has become an increasingly popular means of providing for retirement.
And none of that has changed. What has changed, however, is the means of managing these funds.
Annuities are "wrapped around" mutual funds -- which is simply jargon for saying that annuities have a mutual fund or funds as their underlying investment medium. A decade or so ago, the funds underlying annuities were usually funds owned and operated by the insurance company itself, funds little known elsewhere.
A. Scott Logan -- vice-president of the Massachusetts Financial Service, explains that in those days annuities were run more or less "out of the hip pockets" of the insurance companies. The result, he says, was steady but "lackluster" returns.
Then in the early 1970s, the Insurance Company of North America, in Philadelphia, put its annuity assets into four funds managed by four different investment companies. What this meant was that professional investment management was being brought to bear upon the funds. It also meant that the annuity was dealing in better-known funds, funds whose progress could be tracked in the Wall Street Journal or other newspapers. For many investors, the variable annuity fund suddenly became a more interesting prospect.
Other insurance companies followed suit, some investing in a single family of funds, others spreading their assets about a bit more.
There are today about 10 of these funds which charge no entry or sales fee. Some of these have sprung up very recently. According to information received by the Massachusetts Financial Services, about 20 more are now in registration with the Securities and Exchange Commission, that is, in the process of getting launched. A few of these funds do require an entry fee. A couple of others have neither entry nor exit fees.
Another advantage claimed for investment in these funds is the flexibility they offer. If the capital is invested in a family of funds, it is possible to switch from one fund within the group to another as market conditions or personal needs change.
For example, suppose the money one invests in an annuity first goes into a fund dealing in the bond market. Then interest rates start to shoot up and the bond market no longer seems like a good investment. The investor would be allowed, without a tax penalty, to shift his assets into something else. perhaps a money-market fund.
Then, if that same investor, with an eye toward retirement, were to decide later that it would be nice to have the security and stability of principal that a bond fund offers, he could shift his assets back into the bond fund -- again, without tax penalty.
There is one exception to the funds' tax-deferred status. Long-term capital gains can be taxed, even within the annuity. However, the investor is cushioned a little from the sting of this tax by a "tax reserve." Rather than pass the tax liability directly on to the shareholders, the insurance company withholds a little of the value of each share by setting up the tax reserve.
But because this reserve is only what is known as a "paper entry" (in other words, it exists only in the books), the value of the share continues to work 100 percent for the investor.
Two things should be considered before leaping into a mutual fund annuity. One is the matter to exit fees. Most funds impose them. The fees vary from fund to fund, but their intent is to penalize any early withdrawal of capital. Thus, short-term investment in the funds is not a profitable undertaking. Anyone putting money into an annuity should plan to leave it there for a while.
The second consideration is a more serious, but -- for the moment -- more distant one.That is the possibility that the Internal Revenue Service will close the loophole that gives the funds their tax-deferred status. That loophole has already been closed for annuities attached to savings banks.
Fund managers, however, feel relaxed on that point. A. Scott Logan says, "Anything is possible. But we don't think it's likely." A Potential investor would be wise, however, to keep on top of the latest leg islative developments in this area.