Variable annuities provide the annuity owner with the opportunity to participate in market returns through different investment options available in the contract. Most variable annuities offer a wide range of investment options to suit your risk tolerance, from conservative to aggressive. Variable annuities also offer a fixed option for investors who are interested in keeping a portion of their annuity investment earning a fixed rate of interest.
When an individual purchases a variable annuity the payment (or premium) is invested in a choice of subaccounts that include stocks, bonds, mutual funds, and money market accounts. The return on the variable annuity will depend on the performance of the chosen investments in the subaccounts. There are no guarantees of earning a return, and the annuity owner could lose money. Any growth in the variable annuity is tax-deferred until withdrawals are made.
Variable annuities are designed for individuals willing to take more risk with their money in exchange for the opportunity of greater growth potential. Although there is more risk associated with variable annuities some annuity company’s offer guarantees of principal and downside protection at an additional cost.
A common feature of variable annuities is death benefit. If you pass away the person you have named as your beneficiary (such as your spouse or child) will generally receive the greater of: (1) all the money in the variable annuity, or (2) a guaranteed minimum (such as all purchase payments less prior withdrawals).
Who Can Benefit Most from a Variable Annuity?
Variable annuities can be good for young investors or those who want the opportunity to participate in market returns in a tax-deferred vehicle. If you are looking for a conservative investment or looking for guaranteed retirement income, fixed annuities are a better choice. Variable annuities can be ideal for people who:
- Have a long time horizon (5 to 10 years or more), and are interested in tax-deferred growth.
- Like the idea of being invested in the market and want to control where and how their money is invested.
- Understand market returns will fluctuate up and down, and are comfortable with this risk.
To know if a variable annuity is right for you, you need to consider your individual circumstances.
Variable Annuity Premium Payments
Variable annuity owners typically have two options when making premium payments to a variable annuity – single premium or installment premiums. With a single premium, the variable annuity owner makes a single lump sum payment (premium) into a variable annuity contract. With installment premiums the annuity owner has the flexibility of making a series of payments (premiums) into the variable annuity contract.
When premiums are received by the annuity company money will be invested in the subaccounts established by the annuity owner. Dependent on how much risk the annuity owner wants to take they will have the option of investing in stocks, bonds, money market funds or other equities. The variable annuity owner will also have the option to put part of the premium into a fixed account, with a minimum guaranteed interest rate.
Types of Variable Annuities
There are two types of variable annuities:
- Variable Deferred Annuities
- Variable Immediate Annuities
Types of variable annuities vary according to how benefits or payments are received from the annuity. With variable immediate annuities payments begin shortly after the premium payment is made. With a variable deferred annuity the income stream is received after a specified period of time. Alternatively, there is always the option to cash out your variable deferred annuity all at once.
Variable annuities are most commonly established as deferred annuities because they need time to accumulate earnings. Most variable deferred annuities offer flexible premiums funded over a period of years. Unlike 401(k)s and IRAs there are no limits to what an individual can contribute to a variable deferred annuity.
With a variable immediate annuity you pay a lump sum to an annuity company and begin receiving income immediately. A variable immediate annuity can offer a guaranteed lifetime income with the potential for market growth based on the performance of the chosen investments or subaccounts.
Variable Annuity Payout Options
Variable annuity income payout options are typically received on a monthly basis. However, it is possible to receive income payout of varying frequencies (such as quarterly, semi-annually, or annually). The annuity income received will depend on factors such as age, gender, annuity features, and annuity values. Generally, there are seven types of variable annuity income payout options:
- Lump Sum: Allows the annuity owner to cash out their variable annuity and take the entire value as a lump sum. This could potentially have the greatest income tax consequence.
- Systematic Withdrawal: Provides annuity income based on a specific dollar amount and payment frequency. This income payout option allows the annuity owner to maintain full access and control over the remaining variable annuity account.
- Life Annuity: Provides annuity income for the life of the annuitant. Payments are no longer received after the annuitant passes away.
- Period Certain Annuity: Provides annuity income for a predetermined period of time (such as 10 or 20 years). If the annuitant passes away before the term is over payments will continue to the designated beneficiary for the remainder of the chosen period.
- Life With Period Certain: Provides annuity income as long as the annuitant is alive. If the annuitant passes away before the “period certain” the designated beneficiary will receive payments for the remaining period.
- Joint and Survivor Life Annuity: Provides annuity income as long as either person named in the annuity is living. Payments are no longer made after the second annuitant passes away.
- Joint and Survivor Life With Period Certain Annuity: Provides annuity income as long as both annuitants are alive. If both annuitants pass away before the “period certain” the designated beneficiary will receive payment for the remaining period.
Variable Annuity Things to Consider
A variable annuity can be an important component of your financial and retirement planning, but it is important to make sure it is appropriate for you. Most problems associated with any investment are easily avoidable with the right information. The following is a list of items to consider before purchasing a variable annuity:
- Don’t Purchase a Variable Annuity With Money You Need Today: Surrendering a variable annuity prior to its maturity will trigger surrender charges and penalties.
- Investing Too Young: Withdrawals from a variable annuity prior to age 59 ½ will result in a 10% penalty in addition to ordinary income taxes owed on the gain.
- Diversification: Spread your variable annuity account balance into a minimum of for different asset classes amongst the available subaccounts.
- Surrender Charges: Surrendering or doing a 1035 exchange to another annuity can trigger fees and penalties.
Variable Annuity Summary
To know if a variable annuity is right for you, you need to consider your individual circumstances. Variable rate annuities are usually best for younger investors, investors who can take higher risks, or investors who prefer to make more frequent portfolio adjustments.
Variable annuities are the right investment for you if you are prepared to take a hands-on approach to investing, wish to take advantage of market changes, can withstand higher risk and potential loss, and are able to invest over a longer period of time.
