What Is a Variable Annuity?
A variable annuity is a contract whose value can vary based on the performance of an underlying portfolio of subaccounts. Subaccounts and mutual funds are conceptually identical, but subaccounts don’t have ticker symbols that investors can quickly type into a fund tracker for research purposes.
Variable annuities differ from fixed annuities, which provide a predetermined and inevitable return.
Understanding Variable Annuities
A variable annuity’s value is derived from two sources: the principle, or the amount you put into the annuity, and the returns that the underlying assets in your annuity provide over time.
A delayed annuity is the most common variable annuity. It is intended to produce a regular (monthly, quarterly, or yearly) income stream, beginning at some future time, and is often used for retirement planning reasons. Additionally, there are instant annuities, which start making payments immediately.
Basics of Variable Annuities
The account’s value will increase whether you purchase an annuity with a lump amount or a series of installments. This is often known as the accumulation period for deferred annuities. When the annuity owner requests that the insurer begin the payment phase—the income stream—the second phase begins. After the payment period starts, certain annuities won’t let you take any further money from the account.
Variable annuities, including withdrawal restrictions, should be considered long-term investments. They usually permit one withdrawal during the accumulation period each year. However, there will usually be a surrender cost if you withdraw within the contract’s surrender term, which may last up to ten years. There is a 10% tax penalty for withdrawals made before 59½, much like other retirement account alternatives.
Fixed Annuities vs Variable Annuities
In contrast to fixed annuities, which provide a guaranteed—but sometimes small—payout during the annuitization period, variable annuities were first offered in the 1950s. (A fixed-income annuity is an exception; its payment increases with the annuitant’s age and ranges from modest to high.).
With variable annuities, investors might take advantage of rising markets by choosing from various insurer-offered mutual funds. The plus side was the potential for better returns during the accumulation period and a more significant income during the payout phase. The buyer’s exposure to market risk, which may lead to losses, was a drawback. In contrast, the insurance company bears the risk of fulfilling its stated return in the case of a fixed annuity.
The benefits and drawbacks of variable annuities
Considering the advantages and disadvantages of investing in variable annuities vs. other options is essential before deciding.
Advantages
- Deferred tax growth
- Stream of income based on your requirements
- Unconditional death benefit
- Money not available to creditors
- Cons:
Not as safe as fixed annuities
Penalties and surrender costs for early withdrawal
High costs
Here are a few specifics for each side.
Positives
You can only pay taxes on investment gains once you start getting income or take a withdrawal from variable annuities since they grow tax-deferred. This also applies to retirement funds, such as 401(k)s and conventional IRAs.
The revenue stream may be modified to meet your requirements.
Your beneficiaries can get a guaranteed death benefit if you pass away before the payment period.
An annuity’s money is not accessible to creditors or other debt collectors. Retirement plans often fall under this category as well.
The drawbacks
The underlying investments in variable annuities can potentially lose value, making them riskier than fixed annuities.
Should you have to take money out of the account due to an unexpected expense, surrender fees can apply. A 10% tax penalty may also apply to any withdrawals you make before turning 59.
Variable annuity costs are expensive.
An Annuity: What Is It?
An annuity is an insurance policy where the payout is contingent upon investing money and guaranteed later. When a pension is purchased for a certain amount, the cash is supported and held by the issuing business until the intended payout, often determined by the owner’s age.
Annuities and other investment methods share the goal of the owner investing money in the hopes that it will increase in value; nevertheless, the costs associated with pensions are greater than those associated with most mutual funds.
Which Annuity Earns More, Variable or Fixed?
There’s no easy way to respond to this. Variable annuities offer more earning potential, but they also risk losing money since their interest rate fluctuates in tandem with the performance of the underlying assets. They also have a ton of fees, which might reduce revenue. Usually, fixed annuities provide a steady, lower rate of return. When selecting an annuity, consider your alternatives carefully.
Do annuities have FDIC insurance?
Annuities are not bank products; hence, the Federal Deposit Insurance Corp. (FDIC) does not cover them. But if the insurance provider of the product fails, they are protected by state guarantee organizations.
The Final Word
Investors should thoroughly study the prospectus before purchasing a variable annuity to comprehend the costs, risks, and algorithms for calculating investment profits or losses. Given the complexity of annuities, this may be easier said than done.
Remember that the costs of a variable annuity may mount up rapidly due to the various fees (such as administrative, mortality, and investment management fees) and charges for any extra riders. Compared to other investment types, it may have a negative long-term impact on your results.
Conclusion
- The performance of the subaccounts in the underlying portfolio that the annuity owner selects determines the value of the annuity.
- Conversely, fixed annuities provide an inevitable return.
- Compared to fixed annuities, variable annuities may provide better returns and more income, but there is a chance that the account’s value will decrease.
