What is variable annuitization?
A variable annuity is an option in which the amount of the income payments received by the policyholder will vary according to the investment performance of the annuity. Variable annuitization is one option that the policyholder can select during the annuitization phase of a contract, which is the phase in which the policyholder exchanges the accumulated value of the annuity for a stream of regular income payments guaranteed for life or guaranteed for a specified number of years.
Understanding Variable Annuitization
The life of an annuity is divided into two stages. An investor adds to the annuity throughout the accumulation phase, and any profits accrued during this period are free from current income tax. When a policyholder is prepared to begin receiving income from the annuity, they have two options: annuitize the contract and choose between fixed and variable payments or make withdrawals (sporadically or regularly).
When an annuity is bought with after-tax money, throughout the annuitization phase, a particular portion of each payment is considered a non-taxable return on the initial basis, and the remaining amount is subject to income tax. Alternatively, until all the profits are removed, all annuity income obtained via withdrawals is typically taxed as income.
Withdrawals are non-taxable refunds of the initial (previously taxed) annuity investment made after all profits have been taken out. All income from annuitization or withdrawals is fully taxed as regular income for annuities bought with pre-tax cash.
A Look Into Variable Annuity Features
Investors may find it challenging to choose how they want to be paid from an annuity; this decision often boils down to how much risk the policyholder is prepared to accept about the profits they are hoping for.
Selecting a fixed annuitization ensures that, regardless of the performance of the annuity company’s portfolio, the policyholder will always receive the same amount of money in each monthly annuity income payment during the annuity’s term. However, the value the policyholder gets from variable annuity payments differs because it is intended to change over time. This is because the payouts are contingent upon an underlying portfolio’s performance.
The Financial Industry Regulatory Authority (FINRA) oversees adviser regulation and describes variable annuities as “extremely complex financial products.” “They provide several insurance features that some people may find intriguing. However, it’s crucial to realize that several costs and expenses are associated with those functions. Variable annuities need particular scrutiny since they are expensive and complex.
The length of time your money will be locked up, the surrender charges or other penalties associated with early withdrawals, the financial gain or commission a company receives from selling you the annuity, the risks associated with the investment’s potential loss of value, and the fees and expenses you should anticipate are all factors to take into account.
An annuity purchase might provide some income certainty, but it can also lock money into a product that might not perform as well as anticipated. Annuity sales professionals usually get paid a commission determined by the kind and amount of annuities they sell. The performance of sub-accounts, similar to mutual funds and chosen by the annuity owner, determines the value of variable annuities.
Conclusion
- An investor contributes money to an annuity during the accumulation period, and the profits are permitted to grow tax-deferred.
- The policyholder can annuitize the contract or start making withdrawals when they’re ready to start cashing out.
- The policyholder can make fixed or variable payments if they decide to annuitize the contract.
- An annuity that is variable is precisely what it sounds like. The annuity’s assets’ performance determines the payouts.
- With a variable annuity, there is a greater possibility for profit. However, payouts will be less than those of a fixed-rate annuity during market downturns.
