What’s a variable annuity?

When deciding on the type of investments you can invest in, one of the options you may have is a variable annuity contract. This investment has become a popular retirement and investment option for most Americans due to the various benefits it offers. However, before you invest in an annuity, you should understand how it works and its risks.

A variable annuity is a type of annuity contract between an investor and an insurance company. The contract guarantees a series of payments to the investor, usually when the investor retires or when the surrender period lapses. The amount of return you get depends on the performance of the investment portfolio.

How does a Variable Annuity work?

A variable annuity is a long-term investment, and it allows investors to invest their money in a portfolio of investments known as subaccounts. The value of the annuity contract may increase or decrease based on the performance of these investments. The investments may include stocks, bonds, money market funds, and other investments.

Usually, the return you earn on the initial investment depends on the investment performance. If the investment portfolio performs well, the variable annuity balance increases, hence boosting your annuity earnings. However, if the investments perform poorly, the variable annuity account balance will grow slowly, and you will receive reduced payments in retirement. In some cases, negative returns could make your variable annuity lose value.

The downside to variable annuities is that they typically come with higher fees than other types of retirement savings vehicles. Before investing in annuities, you should research annuities to understand the returns you will earn and the fees you will pay, and decide if a variable annuity is right for you.

Fees associated with Variable Annuities

Variable annuities come with a variety of different fees, which can be confusing to understand. Some of the most common fees include:

Management Fees: This is a fee that the insurance company charges for managing the underlying investments. This fee can be a percentage of the annuity contract value or a fixed amount.

Mortality and Expense Risk Charges: This fee covers the risk that you will die before receiving all of the payments from the contract. It is charged as a percentage of the annuity value, usually about 1.25% per year.

Surrender Charge: This is a fee that you may be charged if you decide to cancel the contract before a certain date. The surrender charge is typically a percentage of the value of the contract. The surrender charge declines gradually over a certain number of years, usually after six to eight years, after which the fee may no longer apply.

Administrative fees: This is a fee that the insurance company charges for administering the contract. This charge can be a flat fee or a percentage of your annuity account balance.

It's important to understand all of the fees associated with a variable annuity before you decide whether or not to invest in one. These fees can significantly reduce your profits if the investment performs poorly.

Risks of Variable Annuities

Variable annuities are not without risk. While they can be a great way to save for retirement, it's important to be aware of the risks involved before you decide whether or not to invest in one.

The biggest risk with variable annuities is that the value of the contract can decline. This can happen if the investments in the underlying portfolio perform poorly. Additionally, many variable annuities come with high fees, which can eat into your profits if the investment performs poorly.

It's important to weigh the risks and rewards of a variable annuity before you decide whether or not to invest in one. If you do decide to invest, be sure to read through the contract and understand all of the associated fees. If the investments in the contract perform poorly, the value of the contract may decrease, and you may lose some or all of your initial investment.

Variable annuity vs. fixed annuity

With a fixed annuity, the insurance company agrees to pay you a set rate of interest on your investment for a specific period. Once that period ends, you can either take your original investment plus any accumulated interest as a lump sum, or you can annuitize the contract and receive periodic payments for a specified period.

With a variable annuity, your funds are placed in one or more sub-accounts, similar to mutual funds. The performance of the underlying investment portfolios will determine how much your investment is worth at any given time. You can choose to take your investment as a lump sum at any time, or you can annuitize the contract and receive periodic payments for a specified period.

Can you withdraw money from a variable annuity?

You can withdraw from a variable annuity at any time. However, there may be penalties or restrictions if you withdraw money in the initial years of owning the investment. When you purchase a variable annuity contract, there is a surrender period that lasts 6 to 8 years, and sometimes up to 10 years. If you withdraw funds before this period lapses, you will owe a penalty, which decreases as you near the end of the surrender period.

If the surrender period has expired, you can decide to convert the annuity into a stream of payments or make a one-time withdrawal. If you choose to receive streams of payments, you will receive periodic payments from the annuity over your lifetime depending on the number of years you choose. You can also decide to withdraw all your money at once. However, if you are below 59 ½ at the time of withdrawal, you could owe an early withdrawal penalty on the withdrawal amount.

Benefits of Variable annuities                                                                              

Variable annuities offer several benefits that can be attractive to investors.

First, variable annuities offer the potential for greater returns than fixed annuities. This is because the value of your investment can go up, depending on the performance of the underlying investment portfolios.

Second, they allow you to choose from a wide range of investment options, so you can find the right mix of risk and return for your needs. The investment portfolio may comprise stocks, bonds, mutual funds, money market funds, and other investments.

Third, they provide tax-deferred growth on your investment, which can help your money grow faster. You won't owe income taxes on the investment returns until you make a withdrawal.

Finally, most variable annuity contracts come with optional riders that guarantee a minimum death benefit or income stream no matter how the underlying investment portfolio performs.

Drawbacks of variable annuities

Some of the drawbacks of investing in a variable annuity include:

Risk of decline

If the underlying investment loses value, there is a risk that the value of the annuity contract will lose value.

High fees

Variable annuities may have higher fees than other comparable investments such as stocks and mutual funds. These fees could eat into the returns earned from the investment.

Surrender charge

If you withdraw your money before the surrender period ends, you could pay a substantial penalty on the amount withdrawn.

Should you invest in a variable annuity?

Variable annuities can be a good long-term investment for investors looking to earn greater returns than what is available with a fixed annuity. They also offer several other benefits, such as tax-deferred growth, a wide range of investment options, and the option of riders that guarantee a minimum death benefit or income stream.

However, variable annuities may have certain limitations such as the possibility of the annuity losing value and withdrawal limitations before the surrender period expires. As with any investment decision, you should weigh the pros and cons of investing in variable annuities before making a decision.