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 In fact, only at the time the money actually withdrawn is when the investor must pay an income tax at their standard rate.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.