Understanding Variable Annuities
A variable annuity is a combination of managed portfolios with various investment objectives and representative holdings. Based on your financial objectives and risk tolerance, you can choose to allocate your payments across various portfolios in any percentage you choose. With a variable annuity, you will not pay taxes on these portfolios until they’re distributed. In addition, you can transfer your assets to and from each portfolio without paying taxes on your gains.
Unlike a fixed index annuity, with a variable annuity your portfolio will be with a professional money manager, meaning you will pay fees for each portfolio under management as well as administrative fees to the managing company. These fees will vary, but can be expensive when compared to other options.
The Basics of Variable Annuities
Variable annuities offer a way to grow your retirement savings in a tax-deferred environment. With variable annuities, your portfolio is managed, and will be comprised of various investments. The income that you receive from variable annuities is determined by the performance of the investments in your portfolio.
Variable Annuity Income Riders:
Depending on your individual situation and needs, variable annuities may offer the following riders:
- Guaranteed Minimum Income Benefit (GMIB) – guarantees you a minimum income stream
- Guaranteed Minimum Accumulation Benefit (GMAB) – guarantees that your account value will accumulate to a certain amount at a specific date in the future.
- Guaranteed Minimum Withdrawal Benefit (GMWB) – guarantees you a minimum income stream without having to annuitize your contract.
Advantages of Variable Annuities
One of the benefits that sparks people’s interest in variable annuities is the potential for long term growth. This growth is determined by the investments, usually stocks or mutual funds, that are in your portfolio and their performance in the market. In addition, any growth in your portfolio is tax deferred until it’s distributed.
Disadvantages of Variable Annuities
Unfortunately for the annuity industry as a whole, the disadvantages of variable annuities have cast a fairly bad name to the annuity name. Variable annuities have been around for quite some time, and while they do offer certain advantages, they are by all means much riskier than any of the other annuity types available.
- High Risk Investments: Unlike other annuities, variable annuities carry a substantial risk for loss. Should the investments in your portfolio perform poorly, the value of your variable annuity will decrease, resulting in a much lower payout to you.
- Higher Tax Rates: You will pay taxes on a variable annuity’s gains when you withdraw, with additional fees should you do so before reaching 59 1/2.
- If you’re under the age of 59 1/2 and you withdraw, any capital gains from stock or bonds subaccounts are taxed as ordinary income when you withdraw.
- Lots of Fees: One of the reasons that variable annuities have cast a shadow over the annuity industry is the fees that are associated with them, even though other annuity products may not include these fees. In addition to early withdrawal penalties, variable annuities also include high sales commissions, as well as management fees (as they’re managed portfolios) and insurance charges. These fees ultimately cut into your returns, and can often run you as much as 5% on a yearly basis.
Are Variable Annuities Right for Me?
While we don’t recommend or sell variable annuities, there are certain circumstances when you may consider them appropriate for your portfolio.
If you have maxed out either your 401(k) or IRAs, variable annuities may be a way to begin boosting your retirement savings. Should you consider a variable annuity, be sure to purchase one with low annual fees and avoid addons that limit long term growth.
Want to Learn More About Annuities?
Schedule your free, no obligation consultation today and let us explain the various types of annuities available and what will work best for your specific situation.