How to Allocate Funds Inside A Variable Annuity

Annuities are contracts between an investor and an insurance company that allows the purchaser to accumulate funds without getting taxed on the income until the first withdrawal is initiated. There are several of different types of annuity products that exist and are offered, each with their own particular benefit and features that may appeal to the investor. For the savvy and novice investor alike, various levels of risk and investment controls can also be appropriated with annuities.

A variable annuity is a tax-deferred annuity and is one that allows its purchaser the freedom to choose among various types of mutual funds and to allocate a particular percentage to each fund with varying amounts of risk. Each variable annuity issuer may provide a number of diverse mutual funds to choose from, including a standard fixed annuity fund option that could complete a portfolio. Ultimately, before electing a variable annuity, the investor is should determine the amount of risk he or she is willing to stomach and then research all available options provided. Some insurance funds, for example, provide higher risk international mutual funds; others provide “socially responsible” funds which meet a particular criteria for companies those funds invest in.

A variable annuity is broken down into two general phases: the accumulation phase and the distribution phase. During the accumulation phase the investor has the ability to allocate his or her investment payments in a number of different mutual funds and with particular percentages for each. The investor usually invests in annuities with either “after tax” or “pretax” funds, which need to be considered when the tax burden is imposed during the distribution or withdraw phase. The distribution phase can be set up according to the investors needs after a certain period of time. For example, the investor may elect to withdraw the funds in one lump sum or take out a percentage per year.

The uniqueness of the variable annuity is that it allows the investor to choose the weight of investment in each fund he chooses. So for example, an investor may elect to allocate 25% of his funds into an international higher risk mutual fund, 40% into a fixed rate fund, and the 35% into a stock fund. Now the overall performance of that variable annuity will be determined by the performance of each of the allocations over a period of time. Each insurance company issuing the annuity may vary on their options, so you should thoroughly research the available funds and their market performance. During the accumulation phase, you may be able to transfer or change mutual fund allocations and their percentages without paying any taxes, but you may incur a fee by the insurance company for the change.

The ultimate factors that may determine your allocation comes down to your savings goals, your comfort level with the risks involved, and your age. For example if you are in your early 30s than you may elect to have some of the mutual funds allocated to a higher risk and potentially higher risk international stock fund. If you are in your late 60s, you may elect to have you larger portion of your fund to be allocated to a fixed fund. If you have a several annuities and other savings vehicles you may consider a balanced approach of allocating a percentage of the funds based on your level of need for the long term.

The most important thing you can do is stay engaged with your variable annuity account. Some insurance providers may offer different mutual funds that may interest you as time passes and that can deliver the return on investment with the level of security you are interested in.

 


Pros and Cons of Variable Annuities

There are several important key elements with variable annuities hat may appeal to investors. Variable annuities as investment vehicles, deliver periodic payments for a predetermined amount of time, such as 20 to 30 years, or the rest of your life. This special characteristic of this type of investment removes the possibility that you may outlive your assets and allows for predictable streams of income throughout a specified period of time.

Another important feature is that variable annuities allow you to predetermine a beneficiary in case you happen to die prior to the company delivering payment on the purchases you have already made. This is particular important for investors who contribute funds and would like to protect and re-designate those funds to a spouse of child in case of their death.

Annuities are contracts purchased for promises of payment in the future and are usually backed by insurance companies. Variable annuities are unique among the other types of annuities because they give the investor a tremendous amount of freedom to invest in several types of “subgroups” based on his or her level of comfort. Usually these subgroups come in the form of stocks, fixed money market vehicles, or bond funds.

Another positive benefit is that the accumulation that occurs is tax-deferred. This means you do not pay any taxes on the income gained throughout the year or throughout the entire accumulation phase of the annuity. For example if you made 10% each year for the last 15 years, you would haven’t have to pay a dime of taxes based on those earnings until you started withdrawing on your funds at some point in the future. This provides the ability for you to grow your income and “defer” your taxes to a later date, when at that time, you may be in a different tax bracket altogether.

With variable annuities you are able to choose the funds you want based on the risk you want to take. So for example, if you are a younger investor and would be interested in generating more funds through a higher yielding and higher risk account, you may choose a particular fund that met those expectations or particular criteria. Another feature that is important for many investors is that if you need to change from one variable annuity to another, you can change accounts without incurring any taxes on that money – although the insurance company may charge you a transfer fee.

There are a few cons to the variable annuity which, in general, may exist for all annuities. Variable annuities are not backed by the FDIC and thereby assume a greater possibility of financial loss if the company issuing the promise of repayment becomes insolvent. Nevertheless, there many states do offer a certain degree of investor protection, which may at as a quasi FDIC. Further, a clear precedent has been established historically, that in case an insurance company goes under, another insurance company or group of companies will step in to buy up the contracts from the insolvent company, albeit for lesser amount of the original payment.

Still, variable annuities remain an attractive and safe option for investors for the long haul providing a level of freedom and flexibility that adheres to the needs and goals of each investor. As with any investment, risk management should include a full assessment of the prospectus and soundness of the issuing company.

 


Understanding Variable Annuities

Variable annuities are contracts that exist to between the issuer, usually an insurance company, and the investor. After its purchase, the annuity makes periodic payments to the investor which can range from an immediate payout or future payments starting on a specified date and lasting for a specified time. Generally, a variable annuity offers a range of investments opportunities that begins when purchasing it in either a lump-sum or pay-as-you-go method. The money invested is then taken by the annuity provider and placed in various mutual funds and/or several equity stocks at the investor’s discretion.

As the investor is able dictate the percentage and type of investment, the ultimate value of the variable annuity depends on several factors; including the amount of the original investment and how the actual annuity performs with each of these “subaccounts” that were elected by the investor – such as bonds, mutual funds, and other equities. For example, it is common to have a particular percentage of your annuity funds to be invested in higher or lower risk mutual funds and perform differently. That percentage increase and decrease will ultimately affect the overall performance of the annuity. The election of each fund, its risk, and its overall weight lies on the discretion of the investor giving enormous freedom in the market place.

One of the essential benefits that come with variable annuities is that they allow you to have a guaranteed “death benefit.” For example, if you were to die before any payments were made to you, you are able to designate a beneficiary who would receive those payments in lieu of you. The amount received by your beneficiary would be, at minimum, the investment payments you have already purchased.

As a tax-deferred vehicle, variable annuities allow you to accumulate assets and pay no taxes on the gains of the investments until you actually make a withdrawal on your account. Another feature that may offer flexibility to the investor is that the variable annuity allows you to transfer money from one account to another, without being taxed or penalized. In fact, only at the time the money actually withdrawn is when the investor must pay an income tax at their standard rate. If you take payments before your retirement or before you turn 59.5 years of age, you will have to pay a penalty fee as you do with other similar annuities, which is usually 10% of the value of the withdraw.

The structure of the variable annuity essentially comes in two different parts: the “accumulation” phase, or the period that the investor makes payments for a designated set of destinations. Variable annuities can, at the same time, provide the opportunity to choose a safer fixed-rate of return, very much like a typical “fixed” annuity. This provides the investor greater flexibility, diversity, and stability that they might be searching for in a balanced portfolio.

During the payout period you can also choose to have your investments plus earnings given to you in one “lump sum” or you may choose to receive payment installments over a specific period of time, such as 20 years. Investors can also elect to be paid out in a manner that is indicative of the market performance of the annuity. Depending on how the investor paid for those investments (either through after tax or pre-tax dollars) will affect his tax obligation when he makes his withdrawals. Nevertheless, the ability to defer taxes on earnings, invest in a number of mutual funds according to the investors aversion to risk, makes this investment a particular favorite.