WSJ Ask an Expert: Should U.S. Expats Buy Variable Annuities?

Chad Creveling |

The Wall Street Journal invited Creveling & Creveling to be part of a panel of experts for personal finance on its WSJ Expat site. The following article originally appeared on the WSJ site and has been shared with permission.

We asked Peggy and Chad Creveling of Asia-based Creveling & Creveling Private Wealth Advisory to discuss the pros and cons of U.S. expats investing in variable annuities. Send your expat finance questions to expat@wsj.comThis e-mail address is being protected from spambots. You need JavaScript enabled to view it . Keep an eye on WSJ Expat to see if your questions — and answers provided by our experts — are published.

Unfortunately, many Americans work overseas for companies that do not provide IRS-approved retirement plans. If you are not contributing to a qualified company-sponsored retirement plan, you can still contribute to a deductible IRA, assuming you have unexcluded earned (salary) income. Keep in mind that the IRA contribution limit for 2015 is $5,500 ($6,500 if you're age 50 or older). And be aware that while your IRA contributions may be deductible for U.S. tax purposes, they may not be in your country of residence.

Given the limited options American expats have for retirement savings, a variable deferred annuity may seem like a good option. A variable deferred annuity is an insurance-linked investment product that provides tax-deferred growth on investments inside the annuity, has no limits on contributions, and provides a death benefit. The benefits may seem compelling, but there are important considerations. While there is no limit on annual contributions to a variable annuity, those contributions are not tax deductible. Earnings accrue on a tax-deferred basis, but upon withdrawal any gains are taxed at your ordinary income tax rates rather than lower long-term capital gains rates.

Variable annuities also typically come with hefty fees that more than offset any tax deferral benefits. There are often surrender charges that can extend over many years, while annual administrative, mortality charges and sub-account fees on underlying investments can easily exceed 2% of the annuity value. In addition, withdrawals prior to age 59½ are normally subject to a 10% penalty on top of taxes on any gains, which are taxed at ordinary income tax rates.

Before locking yourself into an expensive, illiquid annuity structure, consider investing your savings in a low-cost, diversified portfolio in a taxable account. You can often replicate most of the tax deferral benefits, without the costs. Most of the gains in the portfolio will accrue as unrealized gains, which are not taxable until realized. When gains are realized, they are taxed at lower capital gains rates. By using low-cost ETFs, you can limit your portfolio fund fees and minimize your taxable fund distributions. Most of these distributions will be taxed at lower dividend rates rather than ordinary income rates.

Interest on bonds is taxed at ordinary income rates, but you have the option to invest in municipal bonds where interest payments are typically free from federal tax. Finally, there are no expensive surrender fees or early withdrawal penalties.

Given the lower fees, lower capital gains, dividend tax rates, and the ability to replicate most of the tax-deferral benefits, you will typically come out ahead by investing your retirement savings in a low-cost, taxable portfolio rather than in a variable annuity. For more information, please see our online article Do Variable Annuities Make Sense for U.S. Expats?