The Case for Gold in a Variable Annuity

Gold as an investment is as old as it is controversial. Warren Buffett is not a fan of it. 1 First Eagle Global Value Fund’s senior leader Jean Marie Eveillard believes gold “cannot be overvalued.” 2 Former Federal Reserve Bank chief Alan Greenspan ruminated even ruminated on gold recently: “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, however, is not a case for gold. For those who are already sold on gold, this is a case for holding these investments inside a variable annuity.

How an investor buys gold is an important part of the equation. This is partially because of the high costs of investing in the physical commodity. 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. 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 gold?

Owning physical gold may be the least flexible means of investing in gold. Given that gold produces no income, getting any returns from physical gold (as with most commodity-linked investments) requires selling the gold 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.

Most of the various tax shelters mentioned above much more flexibility. In a Brokerage IRA, an investor can liquidate an investment and move it into nearly unlimited options in a very timely manner. Many 401(k) and 403(b) programs allow for transactions, but on a much less immediate time frame, 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 gold-related investments additional to gold itself. These include stocks of gold miners, which pay dividends and can perform differently from the commodity itself. They also include gold as a part of a hard asset portfolio- that is, one of many physical assets such as Real Estate, precious metals, and industrial commodities.

Flexibility is also important for gold investors who prefer to be proactive in their long-term risk-hedging. 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, we aren’t advocating running out and buying a Variable Annuity to house precious metals allocations of your portfolio. We 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.

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.

Gold may be worth your time as an investor, and it may not. We’re certainly of the opinion that all investment decisions need to be made on an individual case-by-case basis. If gold 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 gold investing can be costly.