In order to understand the costs, risks, and formulas for calculating investment gains or losses, investors should carefully research and master a variable annuity’s characteristics with the pros, and cons before purchasing one. A variable annuity is a contract you enter into with an insurance provider that offers a number of investment options. which varies depending on how well the selected investment option performs. Additionally, variable annuity life insurance company operate much like investment accounts, allowing you to select the securities you think will provide competitive rates of return. Stay tuned to understand the difference between a fixed annuity vs variable annuity.
What is a Variable Annuity?
A variable annuity is a financial product that allows you to save and invest for retirement tax-free. The reason it is referred to as a “variable” annuity is because the payments you receive from the annuity change depending on how well the underlying investments perform. Consequently, a variable annuity is an agreement between you and an insurance company. It acts as an investment account that has the potential to grow tax-deferred and includes some insurance features, such as the option to convert your account into a stream of recurring payments.
A variable annuity also allows you to make one or more payments which are then invested in a variety of securities including stocks, bonds, and mutual funds after you make one or more payments into the annuity. In essence, the earnings on these investments are used to pay for the annuity payments that will be made at a later time, usually when you retire.
What Are Variable Annuity Characteristics?
Several characteristics of variable annuities can either be deferred or immediate, qualified or nonqualified,
#1. Tax Deferral on Investment Earnings
Unlike many investments, which are taxed annually, annuities don’t become taxable until the investor takes money out of the account. Taxes can also be delayed using 401(k)s and IRAs, but unlike these products, annuities have no maximum investment amount.
#2. Deferment of a Variable Annuity
Deferred variable annuities pile up money in investments selected by the owner called “subaccounts.” Like mutual funds or other investments, the value of the subaccounts is based on market performance. They’re not guaranteed.
#3. Range of Investment Options
Many annuity companies offer a variety of investment options. For example, individuals can invest in a fixed annuity that credits a specified interest rate, similar to a bank certificate of deposit (CD). If they buy a variable annuity, their money can be invested in stocks, bonds, or mutual funds. In recent years, annuity companies have created various types of “floors” that limit the extent of investment decline from an increasing reference point.
#4. Tax-free Transfers Among Investment Options
In contrast to mutual funds and other investments made with after-tax money, with annuities, there are no tax consequences if owners change how their funds are invested. This can be particularly valuable if they are using a strategy called “rebalancing,” which is recommended by several financial advisors.
#5. Lifetime Income
A lifetime immediate annuity turns an investment into a stream of payments that last until the annuity owner dies. In concept, the payments come from three “pockets”: the original investment, earnings, and money from a pool of people in the investors’ group who do not live as long as actuarial tables forecast. The pooling is unique to annuities, and it’s what enables annuity companies to be able to guarantee a lifetime income.
Factors to Consider When Choosing a Variable Annuity
When it comes to planning and saving for retirement, everyone’s situation is different. which can either be your risk tolerance, time horizon, tax situation, assets, or financial knowledge. All of this plays an important role when choosing a variable annuity plan. So, before you consider buying one, make sure you understand all of its terms below,
#1. What Type of Annuity
The first thing to know is that there are many types of annuities. Generally, annuities are contracts with an insurance company. Some are used to save for retirement while others can be used to help guard against the dangers of outliving your assets. Also, there are three major categories of annuities: fixed, indexed, and variable annuities you can choose from.
#2. Choosing the Right Variable Annuity Plan
The second thing that you need to consider is the right type of annuity plan. We have seen above on annuities that there are two types of annuities when it comes to payout. One is the variable payout, and the other is the fixed payout.
Both of these options have their own set of advantages and disadvantages. Therefore, before selecting the annuity plan, you need to figure out if you want a fixed amount or if you are okay with a variable annuity plan where the monthly payout might fluctuate depending on the market scenario.
#3. Safety
Safety is another important feature that deserves attention. It is because life insurance will pay you income after your retirement. Hence, selecting an annuity from a reputed and well-established life insurance company is vital.
#4. Cost of Variable Annuity
Variable annuities can be expensive, depending on which kind you’re considering. Sample annual fees include mortality and expense risk charges, which are charged to cover guaranteed death benefits, g income for life payout options, or guaranteed caps on administrative charges. These fees can reach 2 percent or more of the annuity’s value. Therefore, if a variable annuity offers features you don’t need or want, reconsider whether it’s an appropriate investment for you.
#5. Taxes and Guarantees
Variable annuities do not offer all the same tax benefits that traditional 401(k)s or other pre-tax retirement plans offer. With a variable annuity, you cannot defer taxes on income and investment gains or reduce your current taxable income. That’s why you should consider annuities only after maxing out contributions to your pre-tax retirement plans.
Additionally, variable annuities often include guarantees such as a death benefit or a payout option that provides income for life. These guarantees are only as good as the insurance company that provides them. That’s why it’s so important to check out the insurance company’s financial strength.
Variable Annuity Life Insurance Company
The variable annuity life insurance company is a subsidiary of American international group or an insurance corporation that specializes in tax-qualified retirement plans and supplemental tax-deferred and after-tax investments at its headquarters located in Houston, Texas. where they operate an open-architecture platform letting participants build a portfolio from several investment funds, including mutual fund families.
In essence, the variable annuity life insurance company operates as an insurance company. The company’s flexible options, managed investments, and innovative digital tools make it easy for participants to manage their accounts at their convenience. To help investors meet their retirement goals.
Services Offered by a Variable Annuity Life Insurance Company
Below are a few of the services rendered by several variable annuity life insurance company:
- Lower fees
- Mixed passive and active assets
- Professional asset allocation
- Automatic adjustments based on investment performance
- Mutual fund programs
- Fixed, variable, and income annuities
- Asset management programs
- Life insurance
- Brokerage accounts
- College savings plans
- Group and individual retirement accounts—traditional IRA, Roth IRA, etc.
- Money Market Consolidator
In addition, it provides annuities and life insurance to more than 25,000 client groups (about 2 million individuals) throughout the United States. They are also part of the domestic life insurance operations of American International Group (AIG).
Fixed Annuity vs Variable Annuity
A variable annuity is a retirement savings account offering tax-deferred investment growth. When you start receiving payments, you pay ordinary income taxes. Variable annuities are notable because they let you make unlimited annual contributions to a tax-advantaged account. But a fixed annuity is an insurance contract that guarantees the buyer a fixed rate of return on their contributions for a specific time.
In essence, fixed annuities are good investments for those interested in premium protection, income for life, and low risk in their retirement fund. Hence, when choosing between a variable annuity vs a fixed annuity, focus on your tolerance level for risk and the necessary criteria in your retirement plan.
Differences Between a Fixed Annuity vs Variable Annuity
Below are the differences between a fixed annuity vs a variable annuity,
Firstly: variable annuities allow you to get exposure to the market, and payouts will depend on market performance. while fixed annuities guarantee a minimum interest rate but sacrifice portfolio growth potential due to not having market exposure.
Secondly, you will be able to transfer your money from one investment option to another within a variable annuity without paying federal tax at the time of the transfer. When you withdraw your money, however, you will pay tax on the gains at ordinary federal income tax rates rather than lower capital gains rates.
Thirdly, variable annuities have greater potential for earnings, but since their interest rate rises and falls with their underlying investments, they can lose money. They are also riddled with fees, which can cut into profits. but fixed annuities earn at a lower, stable rate.
Lastly, your variable annuity contract may have numerous sub-accounts to choose from, enabling you to build a portfolio that’s aligned with your goals. but a fixed variable can pay out any remaining funds to beneficiaries through a death benefit.
Additionally: unlike fixed and indexed annuities, there is no guarantee you will earn interest on your investment. If your investment selections perform poorly, this will affect the value of your annuity. Also, both variable and fixed annuities offer a guaranteed income payout that can last a lifetime.
What is the Best Age for a Variable Annuity?
Several advisors have advised that the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout. But the best time to purchase the annuity, however, depends on the type of annuity you’re interested in and how quickly you want your payments to start.
Due to that, determine the right purchase age for you by considering your individual financial circumstances and goals. Most financial advisors will tell you that the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout.
Pros and Cons of Variable Annuity
A variable annuity is associated with various pros and cons. However, before we proceed, let’s take a look at the pros and cons of variable annuities.
Pros:
#1. Maximized tax benefits
Variable annuities increase from year to year on a tax-deferred basis, just like all other types of annuities. The distributions are taxable in the year that they are made.
#2. Potential for Superior Returns
People who put their money in stock subaccounts and leave it there for 20 years or more will probably see a higher return on their investment than can be had from any other type of annuity. Also, the fixed accounts that are available in many variable contracts are often higher than the rates offered by comparable fixed products.
#3. Bonuses and High Guaranteed Rates
Many variable annuity contracts will pay an instant bonus on money that is paid into the contract, or they may offer a dollar-cost averaging program. That pays a high fixed rate on the initial balance and then moves the money into the subaccounts of your choice over a set time, such as six or 12 months.
Cons:
Depending on an investor’s circumstances, the cons of variable annuities may outweigh their benefits. For others, it could be a matter of understanding the facts. Below are a few cons of a variable annuity:
#1. High Fees
This is one of the cons of a variable annuity. where the fees embedded in variable annuity contracts include commissions, administrative costs, underlying insurance guarantees, surrender charges, mortality expenses, and investment costs. It is not necessarily the variable annuity contract itself, but rather the method by which insurance salespeople are compensated. Additionally, the investments sometimes come with higher fees than simply investing in the same exchange-traded fund (ETF) or mutual fund without using an annuity to do it.
#2. Lack of liquidity
Traditionally, variable annuities are extremely illiquid and oftentimes come with high penalties for accessing funds invested in them prematurely. Also, one of the cons of variable annuities is that they come with a surrender period lasting anywhere from 7 to 10 years. If an investor were to experience a life change that significantly altered their financial circumstances, they would need the liquidity and flexibility to adjust their financial plan along with it.
#3. Complexity
Another cons is that they have several components, features, and guarantees that make up the overall contract. The guarantees, often called riders, are incorporated into the annuity contract and often include minimum income guarantees, principal-protected death benefits to beneficiaries, long-term care coverage, and inflation protection. These guarantees come at a cost and can add up.
References
- ANNUITIES: Definition, Rates, Disadvantages, Immediate Rates, and Guide
- SAFE INVESTMENTS: Top Investments With High Returns in 2023
- Fixed Index Annuity: How It Works (Pros and Cons)
- Are Annuities Good Investments? Everything You Should Know!!
- Total Cost: Definition, Formula, How to Calculate It & Free Tips
- CREDIT CARD RELIEF: Types, Programs, & Governmental Loans
