Annuities Variable Annuity
Variable annuities offer investment features that are quite similar to mutual funds. However, a typical variable annuity offers 3 basic features that are not commonly found in mutual funds. These include:
- Tax-deferred earnings.
- Death benefit.
- Payout options that provide guaranteed income for life.
Normally, there are 2 phases:
- An "accumulation" phase wherein the investor contributions (premiums) are allocated amongst investment portfolios and earnings start to accumulate.
- A "distribution" phase wherein the investor withdraws money as a lump sum or via different annuity payment options.
As the name suggests, the rate of return for a variable annuity is not stable. It varies along with the rate of return for bonds, stocks, and other money market subaccounts that you choose as an investment option. Hence, if you are considering investing in a variable annuity for retirement, remember that there is no guarantee of earning returns on investment and a risk of losing money.
The various features offered by these annuity products can often get confusing. It can become difficult for investors to understand what to buy, particularly while facing a hard-charging salesperson.
Before you consider investing, ensure that you completely understand how does a variable annuity work and all its terms. Here are seven factors you must keep in mind before investing:
1. Liquidity and Early Withdrawal A Deferred variable annuity is a long-term investment. An early withdrawal means taking a loss. It assesses surrender charges for withdrawals made within a specified period. Any withdrawal before the investor reaches the age of 59½ is usually subject to a 10% tax penalty.
2. Sales and Surrender Charges The majority of variable annuities have sales charges. However, like mutual funds, they generally don’t charge a front-end sales charge. However, they definitely impose an asset-based sales charge or surrender charges.
3. Fees and Expenses Besides sales and surrender charges, this product can impose a variety of fees and expenses when you invest. This includes:
1. Mortality and expense risk charges to cover:
- Guaranteed death benefit
- Annuity payout options that provide a guaranteed income for life
- Guaranteed cap on administrative charges
2. Administrative fees, for record-keeping and administrative costs.
3. Underlying fund expenses related to investment subaccounts.
4. Charge for special features like:
- Stepped-up death benefit
- Guaranteed minimum income benefit
- Long-term health insurance
- Principal protection
If you don't want or need these features, you should consider, is a variable annuity a good investment option for you or not.
4. Taxes While the earnings in these annuities are tax-deferred, they don’t provide all the tax benefits of 401(k)s and the other before-tax retirement plans. Hence, investors must only consider this product after making the maximum possible contributions to their 401(k)s and other before-tax retirement plans.
5. Bonus Credits To attract investors, many annuities offer bonus credits that add a specified percentage to the amount invested, generally ranging between 1 to 5 %. However, this is not free. To fund bonus credits, insurance companies impose high mortality and expense charges, and a long surrender charge period.
6. Guarantees Companies issuing this investment product provide a number of specific guarantees. For instance, they might guarantee a death benefit or a payout option that provides income for life. These variable annuity guarantees are only as good as the company that provides them.
Before investing, confirm the following points with the broker:
- Liquidity issues like potential surrender charges and 10 % tax penalties
- Fees which include mortality and expense charges, investment advisory fees, administrative charges and surrender charges.
- How long does the money remain tied up?
- Market risks
Confirm the rates offered by different companies. Use a calculator to make a comparison. If you feel that the product does not cover all you need, you can opt for various riders offered along with the product.
While this type of annuity can be appropriate as an investment under the right circumstances, you should consider - why buy a variable annuity in the first place? Once you are aware of the pros and cons, decide whether this product is right for you and go ahead with the investment.
Due to FINRA compliance reasons, further details must be given by prospectus. The above material is a simple outline of how these investments work in general and should not be used to make a final investment decision. If you would like more information on how a Variable Annuity or other investment strategies may work for you please give us a call and speak with one of our highly trained consultants.