“In a booming economy, variable annuities let you capitalize on the almost certain equity growth of a well-managed mutual fund.”

“Unlike other income deferment choices, there is no limit on the amount of after-tax income you can contribute to a variable annuity.”

One of the best options for tax-deferred investing is a variable annuity. Typically offered by life insurance companies, variable annuities let you invest the purchase price of the policy (net of minor actuarial and administration costs) in equity mutual funds. They don’t guarantee a rate of return; instead, your return depends on the performance of the mutual funds the policy is invested in.

Variable annuities differ from fixed annuities, which do guarantee a fixed rate of return by investing your money (minus costs) in long-term bonds or fixed-income investments. They have become a popular investment vehicle for two principle reasons. One, they are one of the few tax-sheltered investment products that survived tax reform. (Another one that also survived and offers even more benefits is a variable universal life policy .) Second, variable annuities capitalize on the popularity of equity mutual funds among investors. If you are comfortable with the risk/return ratio of mutual funds, you are likely to have the risk tolerance necessary for variable annuities. Furthermore, you can adjust the risk of the variable annuity by switching to more conservative or fixed income funds without tax consequences. Be sure to discuss these options with your financial advisor who can help you stay objective.

Variable annuities offer investors many benefits:

• Variable annuities allow you to rebalance your portfolio at strategic moments without incurring any tax liability for doing so. That means you can take full advantage of the fundamentalinvestment strategies I advocate in all my books and speeches and build your wealth more rapidly. It also means that as your risk tolerance changes over time, which may happen as you age, you can shift your assets accordingly without tax consequences.
• There is no limit on the amount of after-tax income that you can contribute to an annuity contract. This is especially attractive if your annual income exceeds $150,000, or if you start saving later in life and want to catch up. Other tax-deferment plans do limit your contribution.
• You can choose one of several distribution options when you are ready to withdraw the funds. Some of these options include a lump sum payment, a life annuity, or payments of a fixed amount until the accumulated value is depleted.
• When you make withdrawals or receive distributions from the variable annuity, the amount is taxed as ordinary income. Unlike other retirement plans, you can delay distribution until age 85.

The few drawbacks to variable annuities rarely outweigh the many advantages. One drawback is that the fees are a bit higher than those charged to manage a standard mutual fund. A second drawback, which may or may not apply depending on your financial situation, is that distributions from variable annuities are taxed as ordinary income. If your income is higher when you receive the distribution than when you contributed to the annuity, your tax burden may be high.

But neither of these drawbacks mitigates the tremendous advantage of being able to control the equity assets you have invested in the annuity. Depending on your time horizon and income level, variable annuities may also enable you to defer taxes to an age when you will be paying a lower tax rate. These two advantages alone can multiply your wealth and put the lifestyle you dream of for your retirement easily within reach.