About Variable Annuities
A variable annuity has many things in common with its cousin, the fixed annuity. Both are usually initiated with lump-sum payments and offer monthly payouts. The bot also offers tax-deferred income options and tax-free accumulation of capital. But the “variable” component of the variable annuity is unique. It means the interest rate is not fixed but tied to a market-based portfolio of mutual funds.
Your invested money is placed into a carefully managed mutual-fund portfolio, ETFs or similar large-scale market instruments. You have the option to adjust your portfolio, within certain limits. Many people who are drawn to variable annuities view them as a hybrid of life insurance and equity investing.
Variable Annuities FAQs
Annuity contracts are generally categorized as either deferred or immediate. With the latter, you simply pay a lump sum of money to an insurance company and they guarantee a set amount of monthly payments until you die. The company uses sophisticated formulas based primarily on your life expectancy to determine the monthly payout amounts.
Compared to the relatively simple immediate annuity contracts are deferred variations of the original theme. The term “deferred” is the operative element, meaning that you put money into the account over a certain period of time, allowing it to grow tax-free until you withdraw it. The withdrawal period is usually at or after your official retirement date.
Within the category of deferred, also called “tax-deferred”, annuities, there are two main variants: fixed and variable rate contracts. Variable-rate payments are a key feature of the aptly named variable rate annuity. Insurance companies invest your money in mutual funds and the rate your earn is dependent, partially, on how well the market does in given time frame.
A key characteristic of variable annuities is their hybrid nature. The contract owner gets many of the advantages of fixed rates, with guaranteed minimums for instance, as well as the potential to earn higher returns in a rising market. Investors don’t have to worry themselves with purchasing the underlying equities; the insurance company takes care of that chore.
Also known as a “living benefit feature” of an annuity contract, this add-on is purely optional and always cost more. Even though the price is sometimes high, many people opt for it in order to make sure they get at least the amount of the contract principal back. In most cases, the contract must be in force for a minimum number of years, with the principal untouched, before the “living benefits” feature kicks in.
A common way to take living benefits is for the annuitant to receive a payment over a set number of years that is equal to the principal or a higher amount. This “guaranteed minimum withdrawal benefit” allows the contract holder to receive withdrawals at least equal to the principal and payable to either the annuitant of the beneficiary.
Compared to the relatively simple immediate annuity contracts are deferred variations of the original theme. The term “deferred” is the operative element, meaning that you put money into the account over a certain period of time, allowing it to grow tax-free until you withdraw it. The withdrawal period is usually at or after your official retirement date.
Within the category of deferred, also called “tax-deferred”, annuities, there are two main variants: fixed and variable rate contracts. Variable-rate payments are a key feature of the aptly named variable rate annuity. Insurance companies invest your money in mutual funds and the rate your earn is dependent, partially, on how well the market does in given time frame.
A key characteristic of variable annuities is their hybrid nature. The contract owner gets many of the advantages of fixed rates, with guaranteed minimums for instance, as well as the potential to earn higher returns in a rising market. Investors don’t have to worry themselves with purchasing the underlying equities; the insurance company takes care of that chore.
It’s common for variable annuity contracts to offer a death benefit of some kind for an additional payment. When the annuitant dies, the death benefit begins. The so-called “basic death benefit” means that after you die, the insurance company is obligated to pay out at least as much money as you paid into the contract. The payout goes to whomever you name as beneficiary.
Many people are not satisfied with the basic death benefit and thus opt for “enhanced” death benefit features, many of which are quite costly, running into the range of one-half percent per year. Anyone considering purchasing an enhanced death benefit should teak time to do the math and determine whether the potential additional payout to the beneficiary is worth the high price. Death benefit riders for these additional benefits usually cost much more than the basic death benefit.
Investors who want to secure income for retirement often turn to a variable annuity product. There are endless variations based on the companies that offer them, what securities are included in the ownership mix and dozens of other factors. The main things to remember about this kind of investment include the following points:
With variable annuities, you’re essentially getting a set amount of income for life. However, the remainder of the account reverts to the insurance company in the event of your early death (before all benefits have been paid out).
You’ll have to pay a 10 percent penalty to the IRS if you take money out before age 59.5 and pay other fees and penalties to the insurance company as well.
It is imperative to read the fine print on the contract before committing to annuities. Most companies have their own set of penalties, fees and special charges that are often buried in longish paragraphs of legalese.
Always proceed carefully when you are dealing with your retirement income. An annuity can be a very important part of your financial security in many circumstances, but it pays to do research, speak with financial professionals and consider all the alternatives.