Understanding Variable Annuities
Understanding Variable Annuities
Are you considering buying a variable annuity? Variable annuities can help strengthen your retirement portfolio, but they come with both advantages and disadvantages that you need to understand. In this article, we will explain what variable annuities are, the features and benefits they offer, and the risks associated with them.
What is a Variable Annuity?
A variable annuity is an insurance-based retirement plan that combines the tax advantages of traditional retirement accounts with the ability to invest in the stock market. It's an investment-oriented contract between you (the annuitant) and an insurance company: you make payments over a period of time, and the insurance company agrees to pay a sum to you later on (the benefit amount).
The insurance company invests your premiums in various subaccounts, which you select when you purchase the annuity. These subaccounts are comprised of stocks, bonds, or other assets, and your return depends on the performance of the markets.
As an investment vehicle, the main benefit of a variable annuity is its tax deferred growth, which allows your money to compound faster than if it had been left in a taxable account. Additionally, some of these plans have features such as guaranteed benefits, lifetime income payments, and death benefits that can provide financial security to you and your beneficiary after you pass away.
Features and Benefits of a Variable Annuity
Variable annuity products come with a range of features and benefits that make them attractive to investors. Here are a few of the most popular:
- Tax Deferral: Taxes on investment income are not due until you make withdrawals from the plan. This means that you can grow your money faster, since you’re not paying taxes every year like you would in a taxable account.
- Lifetime Income Payments: Many variable annuity plans offer an option for lifetime income payments. This means that you can turn your annuity into an income stream after you retire and receive payments for as long as you live.
- Flexible Withdrawal Options: Variable annuities offer more flexibility when it comes to withdrawals than many other retirement plans. You can choose between lump-sum withdrawals, systematic withdrawals, or annuitization of your assets.
- Diversification: Since you can invest in a range of subaccounts, variable annuities offer the opportunity to diversify your portfolio and reduce your overall risk.
Risks of Variable Annuities
Like any investment, variable annuities come with some risks. Here are some of the potential drawbacks:
- High Fees: Variable annuities typically have a range of fees, including mortality and expense risk charges. These can significantly reduce your returns, so you should be aware of them before you commit to a plan.
- Market Risk: With variable annuities, your returns will depend on the performance of the subaccounts you choose. While this can result in great returns in a bull market, it also means that you could lose a significant portion of your investment if the markets turn sour.
- Surrender Charges: Variable annuities often have surrender charges that can kick in if you cash out your policy early. These charges can significantly reduce the amount you receive and can make it difficult to access your funds if you need them.
- Illiquidity: Variable annuities can be difficult to sell or trade, so you should be prepared to stay in your plan for the long-term if you want to avoid losses from surrender charges.
It’s important to note that variable annuities are considered securities, so they may not be suitable for everyone. It’s important to understand the risks associated with these investments and speak to a qualified professional before making a decision.
Variable annuities can be a great way to grow your retirement savings, but they come with risks that you should understand before you invest. They offer tax deferral, lifetime income payments, and flexible withdrawal options, but they also have high fees, market risk, and surrender charges that could significantly reduce your returns. Be sure to speak to a qualified professional before making any investment decisions.
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- 5. U.S. Social Security Administration. “The ABCs of Annuities.”