A variable annuity resembles a 401(k) — you decide the make-up of your portfolio. The premium can be split into separate sub-accounts and invested into market segments of varying risk. Typical sub-account investment options include money market (ultra-conservative), bonds, mutual funds, and international equities (aggressive).
Variable rate annuities can be bought into with a lump-sum or invested in gradually over time. Variable annuity payouts depend on investment choice and market performance. All gains and losses are yours to own, meaning potential growth, but also potential loss.
Variable Annuity Features
Variable annuities vary, but generally feature:
- Flexible Premium — Pay a lump-sum or invest over time. Reinvest in the same annuity as many times as you’d like.
- Invest in Equity — Stocks and mutual funds yield more (14% long-term average) than debt-based vehicles like CDs or Fixed Rate Annuities.
- Flexible Risk — Risk depends on portfolio choice and market performance. Choose from very conservative to aggressive sub-accounts.
- Adjustable Portfolio — Adjust the composition of your portfolio tax-free. Shift with the market with no penalties.
- Aggressive Growth — Ideal for investors with time until retirement. Yields are high enough for substantial savings growth.
- Variable Returns — Monthly paychecks or return rates will vary depending on portfolio performance.
- Fixed Rate Option — Most variable annuities offer a money market subaccount. Effectively turn your annuity “Fixed Rate” at any time.
- Investment Control — Manage your own money and capitalize on emerging market trends.
- Liquidity — Withdraw as much as 10% annually in the first year without incurring penalties. Withdrawal fees phase out to zero over time.
- 1-10 Year Term — Variable annuities are available for short, medium, or long terms.
- Tax Deferral — Pay nothing on interest earned until you cashout. Earn interest on the IRS’s money.
- Unlimited Contributions — Invest as much as you’d like tax-free without the IRS breathing down your neck. Beats 401(k) and IRA.
- Life Insurance — Optional life insurance provision offers death benefits to loved ones. Save money on a separate policy.
- Inheritance — Bequeath money to loved ones probate-free. Avoid estate/death taxes.
- Tax-Free Gifts — Gift up to $10,000 per individual, per year, tax-free. Gift money to an unlimited number of individuals.
For more discussion on each feature, read: Variable Annuity Features.
Variable Annuity Performance
Historically, variable annuities offer better returns than their fixed-rate brethren at the cost of added risk and short-to-medium term income volatility. While it’s impossible to predict any given year’s return, over periods of 10+ years, variable annuities can yield up to 12%, minus taxes and management fees. It’s important to note that variable annuities can potentially depreciate in value as well.
A variable annuity’s closest analogue is a stock, index (like the S&P 500), or mutual fund. In this next section we take a look at how variable annuities compare to various equities and how they differ from fixed-rate instruments like CDs and fixed annuities. See Variable Annuity Performance for charts and a detailed explanation.
Types of Variable Annuity
The typical variable annuity is of the deferred type — accumulating and compounding interest over a duration of 5 or more years. This is often preferred to take advantage of tax-deferred growth. However, immediate variable annuities are also available, usually as a change of payment option on a deferred variable annuity. Read more about the Deferred Variable Annuity and Immediate Variable Annuity types.
Finding the Best Variable Annuities
Looking for the best variable annuity is all about maximizing flexibility. Unlike fixed annuities, there’s no interest rate to consider, so you should compare plan prospectuses based on withdraw charges, management fees, portfolio reallocation limits, and sub-account investment options. For more information, read: Finding the Best Variable Annuity.
Variable Annuity Disadvantages
Variable annuities feature advantages like tax-deferral, higher performance than fixed-rate instruments, and offer hands-on portfolio management, but like any investment vehicle, the come with a set of disadvantages.
Are variable annuities really right for you? Find out by learning about the unique set of Variable Annuity Disadvantages.
Variable Annuity Pitfalls
Although the basic functioning of a variable annuity are straight forward, the annuity contract itself is nuanced. Be sure to carefully read the variable annuity prospectus before signing anything and look out for excessive management fees, surrender charges, and limited withdrawal allowances. For a full list of potential sticking points, read: Variable Annuity Pitfalls.
Variable Annuity Alternatives
If you’re looking to purchase a variable annuity, chances are you’re looking to build a solid retirement plan. To this end, it’s important to consider how analogous investment vehicles measure up. Which investment yields the highest rate? Which has the highest risk? How do fixed-rate instruments stack up to equity-based ones? To learn the pros and cons of stocks, mutual funds, CDs, money market accounts, and 401(k)s in relation to variable annuities, see, Variable Annuity Alternatives.
Who Should Buy a Variable Annuity
Variable rate annuities are ideal for younger investors, those less risk averse, or those who want to be hands-on. If you’re a conservative investor willing to settle for a lower rate, or simply looking for a guaranteed retirement income, Fixed Annuities are a better choice. If you want to benefit from rising markets, aren’t troubled by the occasional chores of management, and have a long, 5 to 10 year time horizon, a variable rate annuity is right for you.