What is a Variable Annuity?
Variable annuities can seem complicated. In this short primer, we’ll introduce some of the key features of variable annuities so that you can begin to get an understanding of whether or not this is an investment that’s right for you.
A variable annuity is a contract between you and an insurance company. In exchange for an upfront payment, the insurance company will provide payments to you in the future. The payments you receive from a variable annuity may vary depending on market returns, making variable annuities an investment.
With a variable annuity, you are able to participate in the growth of your account by allocating your upfront payment among different investment options in what are known as sub-accounts. Your eventual annuity income will reflect the performance in the account.
These characteristics do come with risks, however (more on that below).
Variable annuities come with tax and other potential benefits. Any earnings on investments in a variable annuity will accumulate on a tax-deferred basis, so that you’ll only pay income taxes once your annuity starts paying out. Your variable annuity may also offer death benefits, which offer a payout out to family in the event of your death. Life benefits can be used to protect the amount of annuity income you receive.
Who is it for?
Variable annuities can be useful for investors with a long-term time horizon who want to supplement their retirement income.
A variable annuity can provide the flexibility and control of selecting the investments within the sub-accounts. Variable annuities can be part of an appropriate retirement income-planning strategy. Having a planned income can help you with budgeting, savings, and determining an appropriate draw-down rate from your retirement accounts.
There are limited contribution limits for an annuity. That means you can take advantage of tax-deferred growth on a large sum at one time. However, it’s important to note that investing large amounts in an annuity will affect your liquid net worth due to potential withdrawal penalties.
When considering whether a variable annuity is right for you, it’s important to have an understanding of your overall financial picture. Your age, income, current and future financial needs, investment objectives, and time horizon are all important factors to consider. For example, if there’s a chance you’ll need to access your investment in the next few years, a variable annuity might not be right for you.
What are the risks?
There are risks to investing in a variable annuity.
With a variable annuity, your eventual income is tied to the performance of your account. If your investments grow, your annuity income could rise. If your investments fall, your annuity income could be reduced.
However, if you’re uncertain about whether you have the appropriate time horizon and risk tolerance to invest in a variable annuity, it’s a good idea to speak with an advisor.
It’s also important to note that there are fees associated with variable annuities. These fees may reduce the performance of your investments. Most annuities charge additional fees if you withdraw your principal before a pre-determined time (typically 5 to 7 years), which means that variable annuities are generally better-suited for investors with a longer time horizon. Similarly, some benefits might only be available if the contract is maintained for a specific period of time.
Finally, make sure to research the annuity company you choose. Any guarantees built into your annuity are contingent on the insurance company’s ability to pay them. In other words, because the stability of your payments depends on the stability of the insurer, you may want to consider working with a company that has a strong track record and a solid credit rating.
Where do I go from here?
A variable annuity can be a useful retirement planning tool, but it’s important to ensure that it’s a suitable investment for you. If you’re considering a variable annuity, take your time and investigate the benefits, fees, and restrictions involved with each potential contract.
If looking for help in making a decision, talking to an advisor about your retirement goals can help.