The following features are common to all variable annuities:
- Variable Returns
- Portfolio Sub-accounts
- Unlimited contributions
A variable annuity works differently than the “classic” fixed annuity. The difference is like that between a 401(k) and CD. There is no guaranteed rate for a variable annuity. Rather, you invest in a professionally managed equity portfolio that’s composed of seperate sub-accounts. The contract owner tells the portfolio manager which investments to make, and how money should be allocated across sub-accounts.
The advantage of variable annuities is full growth ownership; the disadvantage is full loss ownership. Because your portfolio gets vested in market-linked equities and bonds, it’s impossible to predict rates of return for all but very long term scenarios. One year might yield a positive return of 15%, while another might lose 10%. Variable annuities are less predictable than their fixed counterparts but yield better returns. In the end, equities always surpass interest-based vehicles, with averages of 12% over a 30 year span.
Historic Asset Class Yields
Variable Annuity Sub-accounts
A variable annuity portfolio is partitioned into sub-accounts that vest in different asset classes. Sub-account options vary from plan to plan, but can include:
- Money market
- Government Bonds (short-term, intermediate-term, and long-term)
- Corporate Bonds
- U.S. Stocks (blue-chip, aggressive, sector-specific)
- International Stocks
Good variable annuities offer a broad assortment of asset classes to choose from. The benefits are two-fold, diversification and asset allocation. While two strategies may seem similar, they are in fact different. Spreading money across multiple investments within an asset class (like U.S. stocks) is diversification, mitigating against volitiliaty resulting for individual stock performance. Spreading money across mutliple assets classes (like bonds and stocks) is asset allocation, managing your exposure to excessively risky investment vehicles.
Tax-deferral Benefits of Variable Annuities
Variable annuities are tax-deferred. Any income accumulated doesn’t get taxed until it’s withdrawn. As a result, deferring withdrawals to amass a tex-deferred nest egg is the ideal annuity investment strategy. Unlike mutual funds and CDs, which get taxed on an annual basis, your money will compound faster over time, ultimately yielding a much greater balance.
One of the problems with a government sponsored retirement plan, like a 401(k) or IRA is the annual contribution cap. For wealthy investors, or those needing to jump-start their retirement plan, $15,000 per year is not enough. Variable annuities don’t have these limits, giving you the flexibilty of unlimited investment.
An additional feature common to most variable annuities are flexible premiums. Unlike fixed annuities, which only allow a single up-front deposit, variable annuties work like brokerage accounts. The advantage is in being able to invest a smaller premium up front and continue adding to your account in the future. With flexible premiums you can keep funding your retirement plan, varying periodic contributions according to your changing financial position.