If you use a variable annuity as a tax-efficient savings vehicle, it is a deferred variable annuity. Deferred annuities are not the best investment option for most people, but they are good for some people. Read more about deferred annuities.
If you intend buying a variable annuity that will soon start paying you a monthly income, it is an immediate variable annuity.
One key feature that distinguishes variable annuities from fixed annuities is that when you buy a variable annuity, you will have to decide how your money is to be invested.
Your annuity account will offer you a choice of funds to invest in, usually mutual funds. You will be able to choose between stocks, bonds, fixed-interest, and money market accounts, for example. You don’t need to put all your money in one fund. You can allocate your money to different funds in whatever proportions you like. Your monthly payout will be determined in part by how your investment performs.
Variable annuities carry more risk than fixed annuities, because they carry investment risk – the possibility that your monthly payments will fall because the underlying funds they are invested in fall. To counter this, at the cost of higher fees, most insurance companies offer variable annuities with a guaranteed lifetime withdrawal benefit – see later.
The Immediate Variable Annuity Process
If the insurance company you buy your annuity from goes bust, you are in a better position if you have a variable annuity. The assets in a variable annuity are held in your own individual account. The assets in a fixed annuity are part of the insurance company’s general fund; other creditors could have first call on the insurance company’s remaining assets.
Since the money you put into a variable annuity will be invested in mutual funds, you could ask, “What’s the point of a variable annuity? Why not invest directly into mutual funds?”
- Secondly, there’s the possibility of a death benefit providing money for a named beneficiary. You will pay for this, of course.
- Finally, you can opt for monthly income payments that are guaranteed for life, regardless of the performance of the mutual funds you choose to invest in.
You will be paying the insurance company in higher fees for the second and third items, so if you don’t want them, make sure you don’t sign up for them unwittingly. If you want a death benefit, for example, find out if there is a cheaper way of providing it for your own individual circumstances.
Variable Annuity – Guaranteed Lifetime Income
When you retire, the prospect of a stock-market meltdown destroying your income is hardly likely to persuade you to buy a variable annuity. Therefore, for an extra fee, insurance companies offer variable annuities which will provide you with monthly payouts guaranteed not to fall below an agreed level for the rest of your life. The value of the assets in your annuity account is not protected – your mutual funds could lose half their value – but the minimum monthly payment you receive is guaranteed.
Your income will never fall below a certain agreed level, provided you don’t upset the apple cart by selling funds and withdrawing cash from your account – this would certainly mean your guaranteed income would be cut.
In addition to the guaranteed minimum income, you can also benefit from any upward moves in your mutual funds. If your mutual funds were worth double their initial value on the annuity anniversary date, your minimum guaranteed monthly payout would also double. Even if the value of the mutual funds in your annuity account fell later, you would continue to receive the higher monthly payments.
You do pay for this income guarantee – about 1% of your annuity value each year, or perhaps a little more. Remember, your income is guaranteed, the value of your assets is not.
As we’ve said on other pages, in the unlikely event that your insurance company were to go bust, your guaranteed income would disappear too. If you decide a variable annuity makes financial sense for you, make sure you buy one from a company you believe is rock solid. The SEC lists credit rating agencies that assess the financial strength of companies. Better still, don’t put all of your eggs in one basket; buy annuities from more than one reputable insurance company.
Remember, you do not want your variable annuity to be swallowed or to underperform because of early surrender charges or high fees/commissions. Do check these carefully before you buy any annuity.