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September 19, 2002

Achieve SRI Objectives While Deferring Taxes with Variable Annuities
    by William Baue

Variable annuity subaccounts allow social investors with a very specific profile to apply SRI strategies and receive tax benefits simultaneously.

SocialFunds.com -- The term "annuity" traces its roots back to the Latin word annuus, or "yearly." Roman citizens received annua, or yearly stipends, in exchange for upfront investments. In modern times, an annuity functions as a hybrid between an insurance policy and an investment.

Investors deposit money into annuities, which then grow tax-deferred over time, usually decades. Upon reaching retirement age, the investor can withdraw annuity's returns in a lump sum or on a set schedule, known as "annuitization," which usually happens on a more frequent basis than yearly. The investor must pay taxes as they withdraw returns. SRI variable annuities are available from many insurance companies, often in collaboration with SRI firms.

Fixed annuities, which pay a guaranteed rate of return over a fixed period, premiered near the beginning of the twentieth century in the U.S. Variable annuities, which generate potentially higher returns through active investment that introduces increased risk, debuted here at mid-century. Although the variable annuity sounds like a very attractive investment vehicle, it makes sense only for a very select group of investors due to the nature of the product.

First off, 401(k) plans and individual retirement accounts (IRAs) generally represent better retirement saving options, though both are subject to contribution caps.

"An appropriate investor for a variable annuity would be someone who had maxed out their 401(k), they had done their Roth IRA contribution, and they still had additional money that they wanted invested in a tax-advantaged, growth-oriented venue," said Kathy Leonard, president of the Center for Responsible Investing. For example, high net worth individuals might find themselves in such situations. "If I had $300,000 that I wanted to put into a growth-oriented, tax-advantaged investment, there's rarely going to be a retirement plan that can accommodate that dollar amount."

Variable annuities invest in what are called "subaccounts", which amount to tax-deferred mutual funds.

"What variable annuities do is, essentially, combine a mutual fund company with an insurance company, and together they offer that tax advantage, but of course they include additional expenses," Ms. Leonard told SocialFunds.com. "The internal costs on an annuity are higher than on a mutual fund. So you're paying for the tax deferral."

For most investors, the higher internal costs of variable annuities eclipse the tax benefit, as the taxes must be paid as the investor withdraws the returns. Variable annuities might make sense for investors who, in addition to the above conditions, expect to be in a lower tax bracket when they receive disbursements. What's more, variable annuities need to be in place for 15 to 20 years before their tax benefit overcomes the additional fees.

Since variable annuities are essentially identical to mutual funds, many variable annuity subaccounts replicate mutual fund composition. In April, for example, the Calvert Group started accepting investors for two new variable annuity subaccounts that replicate their flagship equity and income mutual funds.

"With over 35 percent sales growth in our products sold through insurance companies, we wanted to offer insurance trust portfolios that are virtual clones of our two most popular funds," said Craig Cloyed, president of Calvert Distributors. The Calvert Variable Series Social Equity Portfolio functions like the Calvert Social Investment Equity Portfolio, and the Calvert Variable Series Income Portfolio replicates the Calvert Social Investment Fund Bond Portfolio. Calvert offers five other socially responsible variable annuity subaccounts.

Ameritas Variable Life Insurance Company and the Equitable Life Assurance Society of the U.S. offer Calvert SRI variable annuity products. Other SRI variable annuity products include the Security Benefit Social Awareness Series, the Variable Annuity Life Insurance Company (VALIC) Social Awareness Fund, and the Dreyfus Socially Responsible Growth Fund.

SRI variable annuity subaccounts replicate not only the composition but also the SRI strategies of socially responsible mutual funds, such as screening and shareowner action.

"Our SRI annuity subaccount is virtually an identical portfolio to our SRI mutual fund, Premier Third Century, just with a different name," Dreyfus Portfolio Manager Paul Hilton told SocialFunds.com. "It is a separate fund because it has to be, legally. But the screens are the same, the portfolio holdings are generally the same, and the process is the same."

Social investors can thus support the same social and environmental objectives in an SRI variable annuity subaccount as in an SRI mutual fund.

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