What is a Variable Annuity?

Beginners Guide to Variable Annuities

With variable annuities, investors have the opportunity to determine how the funds are allocated in their portfolio. Depending on your aversion to risk, you have the ability to invest in “sub-accounts” which range from high to low risk. Some of the areas that you may invest in with a variable annuity are money market accounts, stocks, and bonds.

General Features of Variable Annuities

Flexible Premium: The investor will place premium into the annuity to open the contract and then has the ability to put in additional premium into the same product at a later time.

Invest in Equity: The premium is place in mutual funds and stocks, which offer the opportunity to gain higher yields than a bank CD or an annuity.

Degrees of Risk: The client is able to choose annuity products based on their risk aversion.

Top End Growth: Along with the risk taken, there is a major opportunity for top end growth. This product is ideal for an investor that has a good amount of time before retirement (15-20 years).

Variable Gains: Depending on how the market performs, the investor will receive payments on their product.

Fixed Account: Typically, a variable annuity will come with a “fixed” or guaranteed option. This yield will be much lower than the potential growth in the market, but protects from volatility.

Individual Control: You have control over where in the market the money goes.

Access to Funds: A standard feature on all annuities (fixed and variable) is the opportunity to take out 10% of your investment annually, penalty free.

Varying Terms: The term of contract varies and will have an inverse relationship with potential rates and withdrawal opportunities.

Tax Deferral: The money will grow tax free.

No Limit on Contributions: Investors are allowed to place as much capital as they choose in this product without worrying about their tax liability.

Death Benefit: On most products, there is a death benefit which protects loved ones in the case of death.

Beneficiaries: When you sign a beneficiary to your contract, that money will go directly to them in the case of death.

Variable annuities generally present better returns than fixed products at the cost of added risk and lower accessibility to your premium. Obviously, no one is able to predict how the market will perform, but over an extended period of time, variable annuities can have the ability to return over 10% per year, excluding taxes and management fees. Investors need to understand that with this top end potential, there is an ability to take losses on your initial premium.

The most comparable product to a variable annuity is a stock or bond. In the next few sections we will show you how variable annuities compare to various investment vehicles and how they differ from fixed-rate vehicles like CDs and fixed annuities.

Standard variable annuities are deferred which means it is accumulating interest over a duration of 5 or more years. This benefit of this is that the principal will be able to grow without taxation. Another option is an immediate variable annuity, which is typically used as a different payment option on a deferred variable annuity.

The idea is to find a variable annuity that has the most flexibility possible. When searching for a fixed annuity, one of the most important factors is the interest rate. Due to its involvement in the market, this is not a concern with a variable annuity. Therefore, you should compare variable products based on surrender fees, management charges, portfolio reallocation limits, and sub-account investment options.

Although the basic outline of a variable annuity is common sense, the annuity contract itself is complex. Investors are encouraged to cautiously read the variable annuity contract before committing to anything. It’s important to be wary of extreme management fees, surrender charges, and inadequate withdrawal access. Variable annuities are perfect for investors with some time left before retirement. It is also ideal for buyers with less aversion to risk. Thirdly, it’s a nice option for investors that like to control their principal and participate in the performance. These are not for everyone, so if you’re looking for less risk of loss, or are maybe willing to settle for a lesser guarantee, then fixed/fixed indexed annuities are a better route for you.

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