The Case for Precious Metals in a Variable Annuity

There’s no doubt that gold and precious metals are a hot topic right now. The rally in gold and precious metals are hardly just Wall St. buzz at the moment- as of writing this, State Street Advisors is reporting that cash inflows (i.e. purchases) into Gold ETF’s hit $8.79 Billion this quarter. That’s the second highest inflow in the history of Gold ETF’s. According to Morningstar, State Street’s Gold ETF NYSE: GLD has returned 23.6% over the past year.

One critique of gold and precious metals investing is that it produces no cash flow. As an investor, you don’t collect interest payments and you don’t get paid dividends. This means that to actually capture total return, you have to sell your stake. For those of you who rebalance portfolios annually, gold and/or precious metals will likely be a larger than desired slice of your portfolio the next time you rebalance. The tax implications of doing so can be troublesome, as precious metals are taxed as collectibles.

With that in mind, I thought it’d be a good time to revisit the topic of precious metals in a Variable Annuity. It all comes down to taxes, which are a major concern for precious metals investors. Selling precious metals in a Variable Annuity does not create a taxable event, and capital gains are not owed when you make this sale. You’re only taxed when you take your returns out of your Variable Annuity. You have a great deal of control over when and how you take your returns out of your annuity.

Gold and precious metals as investments is as old as it is controversial. I’ve remarked before that Warren Buffett is not a fan of it 1 while one of my Value Investing icons, First Eagle Global Value Fund’s senior leader Jean Marie Eveillard, believes gold “cannot be overvalued.” 2 Former Federal Reserve Bank chief Alan Greenspan said of gold: “Gold is a currency. It is still, by all evidence, a premier currency. No fiat currency, including the dollar, can match it.” 3 This article, like other articles I’ve written on gold in the past, is not a case for gold or precious metals. I’m assuming you’re already interested in precious metals if you’re reading this. This is simply a case for holding these investments inside a Variable Annuity should you own them in the first place.

How you buy precious metals matters. Investing in physical precious metals can be costly. Between storage, insurance, and premiums on gold, it can get expensive to own. It’s also important because of taxes. Gold is taxed at one of the least favorable rates in the United States: it’s taxed at the “collectibles” rate of 28%. At that rate, gold needs to outperform other investments substantially to break even with them after taxes.

As Marketwatch explains, investors in the 28%, 33%, 35%, and 39.6% brackets are taxed at 28% on their net long-term gains on gold and precious metals. High income investors who owe the 3.8% net investment income tax may end up paying the maximum effective federal rate of 43.4%. 4

Given that gold is a tax-inefficient investment, it should be sheltered in one of the many available structures when possible. These range from the very flexible (IRA, Roth IRA, etc.) and the somewhat flexible (401(k), 403(b), SEP-IRA) to the less flexible “gold IRA’s.” As a means to inexpensively invest nearly unlimited sums with tax deferred growth, Investment Only Variable Annuities deserve a place in this conversation. Broadly speaking, they’re a good place to hold tax inefficient assets for long periods of time. What fits that bill better than precious metals?

Owning physical precious metals may be the least flexible means of investing in precious metals. Given that they produces no income, getting any returns from physical gold, silver, etc. requires selling them for a profit. Doing so on large investments of physical assets can be unwieldy and expensive, and reinvesting the proceeds can be costly in terms of time and effort of getting into other assets. See our panel bellow, Silver Coins, A Case Study for an example of what we mean.

All of the tax shelters (401(k), IRA, IOVA, etc) are more flexible. In a Brokerage IRA, an investor can liquidate an investment and move it into nearly unlimited options. These days, this can be done from home and in a single afternoon in some cases.  Many 401(k) and 403(b) programs allow for transactions, but on a more structured time frame controlled by the 401(k) manager, and reinvestment options are much more limited. Investment Only Variable Annuities have the rapid experience and unconstrained transactions of a Brokerage IRA, but investment options (while expansive) are limited to Fund investments (much like a 401(k)).

Beyond transactional flexibility and liquidity, the Investment Only Variable Annuity (IOVA) allows investors to invest in various precious metals and gold-related investments additional to gold itself. These include stocks of miners, which pay dividends and can perform differently from the commodities themselves. They also include precious metals as a part of a hard asset portfolio- that is, one of many physical assets such as Real Estate, gold, and industrial commodities.

Flexibility is also important for precious metals investors who prefer to be proactive in their long-term risk-management. Gold has a negative relationship with inflation, for example. It often goes up in price when inflation increases. It doesn’t tend to do as well when inflation is low or there is outright deflation (that is, a decrease in values of goods and services). Long term bonds and certain Real Estate investments tend to do well during deflation. These investments are also tax-inefficient, and great for a tax deferred account. An investor could efficiently shift hedges- or maintain hedges over very long periods- with tax deferred growth within a Variable Annuity.

To be clear, I absolutely don’t advocate running out and buying a Variable Annuity to house precious metals allocations of your portfolio. I like to see a judicious use of all available options before using an annuity. An Individual Retirement Account (IRA) is all some people need, and when it comes to taxes, it can be the best option. As mentioned above, investing in precious metals ETF’s can be a very attractive means of investing, especially when combined with an appropriate privileged account.

After that, workplace retirement accounts should be used up absent some extreme mitigating factor. For many families, a maxed-out IRA and 401(k) can replace 80% or more of income in retirement years, given a long enough timeline and an efficient approach. SEP-IRA, SIMPLE IRA, and other small business retirement plans can also meet these needs when available. Taking advantage of employer contributions is crucial for retirement savers.

After those resources have been used, that’s when annuities become potentially useful. Particularly where very large lump sums of taxable money is received in a given year (an inheritance, for example), other tax deferred investment options may not be available when they’re needed most. Imagine paying 43% taxes on precious metals capital gains over multiple decades- the tax inefficiency of doing so may equal years worth of income on high enough sums.

There’s no reason an investor, saver, or “stacker” can’t use multiple strategies of precious metals ownership. One could keep a “stash” of physical gold and/or silver in personal possession while holding larger, more tactical allocations in a tax-privileged account. For those very concerned with having physical alternative liquidity, this might be appealing. Particularly because gold held in physical possession is rarely sold outside of a monetary crisis, the tax implications of this strategy may never be realized.

What’s important is finding the most appropriate place to hold tax-privileged precious metals investments. One doesn’t need some gold in an IRA, some in a 401(k), and some in a Variable Annuity. Often, one of these will be better than the other as an option (perhaps the 401(k) has high expense fees on its gold option while the IRA has low expenses, for instance). We highly recommend seeking assistance from an investment and/or tax professional in making such a decision.

Precious metals might be worth it for you as an investor, and they might not. I believe that all investment decisions need to be made on a case-by-case basis. If gold or precious metals is something you’re committed to, first make a tax-savvy strategy. As we’ve shown, an Investment Only Variable Annuity deserves some consideration as a suitable vehicle for long term precious metals investing. In any case, the consequences of not having a tax conscious approach to precious metals investing can be costly.