Given the widely-touted benefits of variable annuities, the question inevitably arises: Why not counsel clients to put all of their nest eggs in a VA when they can enjoy potentially unlimited gains without also bearing the investment risks associated with alternative retirement planning vehicles?

Advisors contacted by National Underwriter say prudent planning dictates that clients spread their investable assets among several products, varying the amounts according short, medium and long-term liquidity needs, while also taking into account the tax consequences, relative risks and rewards, and — not least — the costs of other products.

“If someone buys a no-load mutual fund with an asset management fee of 0.45%, then obviously that’s going to beat the pants off the higher fees of a variable annuity,” says Cliff Berg, a principal at Financial House, Bloomington, Del. “The question a client should ask is, ‘What am I getting benefit-wise for the additional cost of a VA versus placing funds in an alternative investment vehicle?”

Measured in terms of guarantees, those benefits are by any measure substantial. Unlike other equity-based products, such as stocks and mutual funds, VA holders enjoy guarantees on the death benefit, the insurance fee, and the duration or amount of the income stream. For an added charge, boomers can secure additional riders insuring a minimum income, withdrawal and/or accumulation benefit.

But sources say these guarantees have to be counterbalanced against the lower cost of alternative solutions and, indeed, the need for the guarantees. Clients who have a high risk tolerance level and/or a substantial financial cushion might be more inclined than others to trust the market to provide historically high returns, free of any safety net. The guarantees become progressively more important the nearer the time is to retirement and the extent to which financial comfort, during retirement, will depend on protection of principal and earnings.

“As with any investment plan, it’s always important for clients to know or explore how much risk they can assume,” says Timothy Johnson, a financial planner with Lincoln Financial Group, Philadelphia. “If the guarantees aren’t necessary or desirable, then they shouldn’t be paying for them.”

Tax considerations should also be weighed. Like qualified retirement accounts, non-qualified variable annuities offer tax-deferred growth on earnings. That advantage, over products that don’t enjoy similar tax treatment, becomes “hard to beat” when the investment horizon is 10 years or longer, says C. Brent Wilmoth, a Fairmont, West Virginia-based retirement planning specialist with AXA Advisors.

However, VAs are counted as ordinary income and, therefore, subject to income tax. Individuals or couples occupying the top tax bracket at retirement can expect to pay 35% on distributions. Contrast this with the 15% long-term capital gains rate on stocks and mutual funds. By placing part of their retirement savings in the latter vehicles or other taxable investments, boomers can limit their income tax exposure, sources say.

Additionally, annuity distributions are subject to estate tax. But as Wilmoth notes, VA inheritors can avoid probate court — and potentially costly litigation. The reason: In the event of conflicting claims over the distribution of estate assets, beneficiaries designation’s in annuity contracts override those named in wills, revocable living trusts and other estate planning documents.

“By avoiding probate, the annuity can provide a client with the liquidity needed to quickly settle estates,” says Wilmoth. “If the estate is large, that’s going to be the number one consideration.”

How much of ones’ retirement assets can one safely invest in a VA without risking a cash-crunch or, in the event the annuity’s assets need to be prematurely drawn down, paying a federal tax penalty or surrender charge? Advisors generally peg the percentage at 50% or less, the actual percentage depending on the client’s unique financial obligations and alternative sources of income.

Wilmoth counsels clients to distribute savings among several “buckets:” a savings account to help clients meet unanticipated expenses over a 3 to 6-month period; a second bucket to supplement other sources of retirement income and fulfill medium-term objectives; and a retirement account, such as a 401(k) or IRA, that can fund retirement needs for the long haul.

“If buckets 1 and 3 are exceedingly short of money or if the client hasn’t even started funding them, then that would be a reason to limit investment [in a variable annuity],” says Wilmoth. “We’ll actually stop clients from funding [a VA] until they have bucket 1 under control. The lack of savings creates the greatest opportunity for generating bad debt because clients are prone to running up charge cards to fund unanticipated expenses.

“Recognizing that an income plan is not cast in stone is critical,” adds Gary S. Chard, a senior financial representative at Principal Financial Group, Des Moines, Iowa. “Having a retirement investment strategy that is flexible is essential to proper management. Therefore, a heavy emphasis on one type of investment or another…may skew a prospect’s ability to move with their changing lifestyle.”