Key Takeaways
- Converts variable annuity from growth to payout phase.
- Payments fluctuate based on investment performance.
- Offers lifetime or fixed-term payout options.
What is Variable Annuitization: What It is, How it Works?
Variable annuitization is the process of converting a variable annuity from its accumulation phase, where your funds grow tax-deferred through investments like mutual fund subaccounts, into a payout phase that delivers periodic payments fluctuating based on investment performance. This transition shifts your contract from growth-focused investing to income distribution.
Unlike fixed annuities, variable annuitization exposes your payouts to market volatility, offering the potential for higher returns but also variability in income. Understanding this process can help you align your retirement income strategy with your risk tolerance and investment goals.
Key Characteristics
Variable annuitization features several distinct aspects that differentiate it from other retirement income options:
- Tax Deferral: Earnings grow tax-deferred during accumulation, allowing your investments to compound without immediate tax impact.
- Investment Options: You typically choose subaccounts similar to mutual funds, which may include options like FNILX or IVV to tailor risk exposure.
- Payout Variability: Income payments vary with the performance of underlying investments, unlike fixed payouts.
- Death Benefits: Many contracts include death benefit riders returning premium or account value to beneficiaries if you pass away before annuitization.
- Fees and Expenses: Variable annuities often involve mortality and expense charges, surrender fees, and management costs, sometimes influenced by share class such as A shares.
How It Works
The variable annuitization process occurs in two phases. During the accumulation phase, you allocate your payments to investment subaccounts, which grow tax-deferred based on market performance. You maintain control over your investment choices and can adjust allocations within the contract's options.
When you elect to annuitize, the contract enters the payout phase. The insurer calculates your periodic payments using factors like your account value, age, and selected payout option. Because payments depend on investment returns, your income can increase during strong markets or decline during downturns, demanding careful planning for income stability.
Examples and Use Cases
Variable annuitization suits investors seeking growth potential with retirement income flexibility. Here are some practical scenarios:
- Retirement Income: A Baby Boomer (Baby Boomer) nearing retirement might convert a $300,000 account invested in diversified subaccounts into variable payouts to maintain exposure to market growth while receiving income.
- Portfolio Diversification: Incorporating fixed income funds like BND into your annuity subaccounts can balance equity volatility and smooth income fluctuations.
- Investment Management: Post-annuitization, insurers manage the portfolio to support payments, similar to duration-focused strategies using concepts like Macaulay duration to match liabilities.
Important Considerations
Variable annuitization offers growth and income but comes with trade-offs. Market volatility means your payments can vary year to year, requiring you to assess your income needs and risk tolerance carefully. Also, annuities may impose surrender charges and fees that affect your net returns.
Taxation on withdrawals is at ordinary income rates, and early withdrawals before age 59½ may trigger penalties, so consider these factors when planning your income strategy. Consulting with a financial advisor can help tailor annuitization choices to your personal retirement goals and ensure you understand the implications of options and riders available.
Final Words
Variable annuitization lets you convert your investment into flexible income that adjusts with market performance, balancing growth potential with payout variability. To determine if this strategy fits your retirement plan, compare payout options and run projections based on your expected lifespan and risk tolerance.
Frequently Asked Questions
Variable annuitization is the process of converting a variable annuity from its accumulation phase, where funds grow tax-deferred through investments, into a payout phase that provides periodic payments. These payments fluctuate based on the performance of the underlying investments.
During the accumulation phase, your funds are invested in subaccounts like mutual funds, allowing your account value to grow or decline with the market. Earnings grow tax-deferred until you decide to withdraw or annuitize.
Payments are calculated based on your account value, age, life expectancy, and chosen payout option. Unlike fixed annuities, the amounts vary with investment returns, increasing in good markets and decreasing in poor ones.
Common payout options include lifetime payments, period certain payments (e.g., 10 or 20 years), and joint and survivor plans that cover you and your spouse. Each option offers different guarantees and payment durations.
Yes, because payments vary with investment performance, your payouts can decrease if the underlying investments perform poorly. This variable nature means there is some risk compared to fixed annuities.
Many variable annuities offer death benefits during accumulation, such as returning your premium or account value to beneficiaries if you pass away before annuitization.
Forced annuitization often happens between ages 85 and 95, ending living and death benefits and converting the account into guaranteed payout streams based on formulas that may include minimum return requirements.
During accumulation, earnings grow tax-deferred, meaning you don’t pay taxes until you withdraw or annuitize. Once payments begin, the taxable portion depends on the gains and your withdrawals.
