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  • Writer's pictureAntonise De Wet

The variable annuity

A Variable Annuity: What Is It?

With a variable annuity, you can buy the right to receive a stream of income for your lifetime or a predetermined length of time from an annuity provider - typically an insurance company. Your payment for a variable annuity is divided among a variety of investments. For how to invest the money in your portfolio, you will have a variety of possibilities. Stocks, bonds, money market funds, stable income value mutual funds, and other investments are examples of these possibilities, or subaccounts. Depending on the success of the portfolio, the amount of income you receive may increase or decrease.

a variable annuity's rate of return:

A variable annuity's rate of return is calculated in a very different way than a fixed annuity's. The distinction is comparable to that between a money market account and a mutual fund. A variable annuity offers the possibility of bigger upside growth but has no guaranteed rate. Your money is invested in stocks that are divided up into different sub-accounts with different investing possibilities. You decide which investments are used and how much money should be distributed across the various investing options. Positively, variable annuities do have an unlimited potential for upside return; negatively, they do not provide protection from losses on the downside.

Let's examine each benefit a variable annuity provides:

1. Flexibility and Choice

Diversification is crucial for reducing the danger of losing money when investing, and this is a point on which almost everyone can agree. The majority of variable annuities provide a selection of investing choices in a number of different asset classes, strategies, styles, and sectors. In depressed markets, spreading your money around investments might help lower your risk. You can move money between investment options with variable annuities without incurring sales or withdrawal fees.

2. Annuity Tax Advantages

Any increase in your account with a variable annuity is tax-deferred until you begin taking withdrawals at a later date (when you may be in a lower tax bracket). As a result, all of the money that would have been paid in taxes each year remains in the account and has the potential to grow until it is taken. You also have the option of rebalancing or strategically moving money within your investments without incurring annual taxes. A variable annuity also allows you to adjust or strategically move money within your investments without incurring year-end taxes. It's critical to understand that you can only benefit from tax deferral if you purchase your annuity with funds from sources other than "qualified" retirement accounts like 401(k)s, 403(b)s, and IRAs (because these are tax-deferred already). Many people do so nonetheless because they wish to take advantage of the annuity's additional features and benefits, such as death benefit options, a variety of investment alternatives, and guaranteed income payout options.

3. Income Guarantees

Annuities provide two ways to guarantee your retirement income:

  • Annuitization: When you're ready to start receiving income, you can annuitize, which means you give the insurance company management of the money in the account in exchange for a monthly stream of income payments in retirement. Those payments would be made for life, for a set amount of time (usually 10, 20, or 30 years), or a mix of the two (eg. life with 10 years). When you die, the insurance company will satisfy any outstanding payment obligations to your dependents for the time period you specify, while keeping any remaining money.

  • Optional Lifetime Income Guarantees: In addition to annuitization, today's annuities include living benefits, which function similarly to annuitization but with greater flexibility, for an additional cost. These benefits include income guarantees, including lifetime income, thereby insuring your future income without sacrificing absolute control over your money. When you purchase a variable annuity with an income guarantee, your future income level can be protected even if your account’s investments perform poorly. In addition, some living benefits offer guaranteed income growth as well as the opportunity to capture gains when the market goes up. Once you begin taking income you can withdraw up to a specific amount each year as a guaranteed income stream for life, subject to the limitations outlined.

4. Legacy Security

Most annuities now include a typical death benefit to assist in leaving a legacy for your loved ones. It usually works like this: when the owner dies, the beneficiaries receive at least the amount paid into the annuity, less any withdrawals, OR the current account value of the annuity, whichever is larger. This death benefit is typically integrated into variable annuities at no additional expense. For a price, certain annuities provide greater death benefits. Variable annuities provide an unusual combination of insurance and investing advantages:

Tax deferral the prospect for assured lifelong income legacy protection are all options and flexibility. These benefits can be extremely valuable, especially for investors trying to improve the comfort and security of their retirement.

The Bottom Line

Variable annuities can provide you with benefits that would take a combination of several different types of investments and accounts to replicate. However, you must be well-versed in their disadvantages. The worth of these products can only be determined in light of your tax status, investing and retirement goals, and time horizon.


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