Investors who use investment strategies that center on dollar-cost-averaging or asset allocation may be able to reap greater returns with a variable annuity than they can with mutual funds, according to a study released last month by the National Association for Variable Annuities.

The study, prepared for NAVA by PricewaterhouseCoopers of New York, shows that the return on $1000 invested in a variable annuity can exceed the return from a mutual fund by between $210 and $33,762 with the use of dollar-cost-averaging or asset allocation strategies.

"The analysis in this report generally shows that variable annuities are attractive investments for long-term savings outside of qualified plans where Dollar Cost Averaging or Asset Allocation rebalancing strategies are used," the report said. "Long-term savers generally receive higher after-tax payouts through variable annuity investments relative to similar investments in mutual funds."

Dollar-cost-averaging is used by investors concerned with volatility in the markets. In order to avoid sinking a large investment into the market all at once, investors park their money in a cash or fixed-interest vehicle, like a money market fund or certificate of deposit, and move the money into the market in equal installments over an extended period of time, usually six to 12 months.

"A disadvantage of Dollar Cost Averaging outside of a variable annuity is that the cash investment from which funds are being transferred typically generates fully taxable ordinary income," PricewaterhouseCoopers said. "A variable annuity investor, however, can undertake the Dollar Cost Averaging strategy while deferring tax on all income until distributions are received."

That gives the variable annuity investor two advantages over the mutual fund investor when making investments outside a qualified pension plan. By delaying the payment of taxes while the investment is in the variable annuity, money that would have been used to pay taxes remains invested to generate returns for the investor, the study said. In addition, because the investor does not start withdrawing money until he retires, chances are he will be in a lower tax bracket than he would be when he was accumulating assets in the variable annuity.

Asset allocation is used by investors who wish to diversify their holdings to reflect their tolerance for risk. The PricewaterhouseCoopers study assumed its model investor put 77 percent of his money in growth funds, 13 percent in balanced funds, seven percent in bond funds and three percent in money market funds. To maintain the proportions, an investor must move money among the funds periodically, since each asset category will perform differently during any given time period.

"Using mutual funds, this rebalancing triggers capital gains taxes that otherwise might be deferred," the survey said. "Exchanges between variable annuity sub-accounts, however, do not result in current taxation. As a result, taxes may be deferred until distributions are received."

In arriving at its conclusions, PricewaterhouseCoopers made a series of assumptions that could alter the impact of the study's findings for some investors for whom the assumptions do not hold.

One of those assumptions is that an investor would stay with his annuity for the long term and not be hit with the premature withdrawal penalties that apply to distributions from an annuity before age 59.5 or with surrender charges for short-term annuity investments.

"Investors for whom these assumptions are not appropriate may find variable annuity investments less attractive than as modeled in this report," PricewaterhouseCoopers said.

Another assumption underlying the report is that annuity investors would be in the 28 percent tax bracket while they are accumulating assets in their variable annuities and in the 15 percent bracket when receiving their distributions. With the 28/15 assumption and using a dollar-cost-averaging strategy, variable annuity returns exceeded mutual fund returns by $1,522 to $15,627.

The variable annuities' returns vary based on their asset type (growth, balanced, bond or specialty), load (no-load, front-end or deferred) and distribution method (lump sum, term certain, variable annuitization for life or systematic withdrawal).

Other tax scenarios, however, are illustrated in the study.

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