Key Takeaways
- Variable annuities offer market-based investment returns.
- Principal and interest are not guaranteed.
- Higher fees than fixed annuities.
- Flexible investment options with growth potential.
What is Variable Annuity?
A variable annuity is a type of insurance contract that allows you to invest your premiums in a selection of market-based portfolios, with the goal of achieving growth over time. Unlike fixed annuities, the returns on variable annuities depend on the performance of underlying investments, making them subject to market fluctuations. This product offers tax-deferred growth and the potential for higher income during retirement, but also involves more risk.
Understanding valuation principles can help you assess the potential value and risks of variable annuities before investing.
Key Characteristics
Variable annuities combine investment flexibility with insurance benefits, featuring several distinct traits:
- Market-based returns: Your account value changes based on the performance of selected subaccounts, which can include equity or bond funds.
- Investment control: You choose how to allocate your premiums, offering tactical asset allocation opportunities to adapt to market conditions.
- Tax deferral: Earnings grow tax-deferred until withdrawal, enhancing long-term accumulation potential.
- Higher fees: Variable annuities generally carry higher management and insurance fees compared to fixed annuities.
- Lifetime income options: You can convert your accumulated value into guaranteed lifetime income, though payments fluctuate with investment results.
- Risk exposure: Your principal is not guaranteed and is subject to market volatility, unlike fixed annuities.
How It Works
When you purchase a variable annuity, your premiums are invested in a range of subaccounts that resemble mutual funds, allowing you to benefit from market growth. Your account value rises or falls with the performance of these investments, giving you the potential for higher returns compared to fixed annuities.
You have the flexibility to change your investment allocations, employing a tactical asset allocation approach to manage risk and seek growth. Additionally, the tax-deferred status means you won’t owe taxes on earnings until you start making withdrawals, which can be advantageous for long-term retirement planning.
Examples and Use Cases
Variable annuities can suit investors seeking growth potential combined with insurance benefits. Here are some practical examples:
- Retirees with growth goals: Baby boomers looking to supplement Social Security income while maintaining some market exposure may consider variable annuities.
- Portfolio diversification: Investors using bond ETFs like BND can complement fixed income with variable annuities for equity exposure.
- Long-term tax deferral: Those interested in tax-efficient accumulation might explore variable annuities alongside other tax-advantaged investments.
Important Considerations
Before investing in variable annuities, consider the higher fees, market risk, and the complexity of the product. Your returns are not guaranteed, and poor market performance can reduce your account value. It’s essential to evaluate your risk tolerance and time horizon carefully.
Consulting resources such as the best bond ETFs can help you balance your portfolio and understand how variable annuities fit into your overall investment strategy.
Final Words
Variable annuities offer the potential for higher returns through market exposure but come with increased risk and fees compared to fixed annuities. Review your risk tolerance and financial goals carefully before committing, and consult a financial advisor to compare options that best fit your retirement strategy.
Frequently Asked Questions
A variable annuity is a type of insurance contract that allows you to invest your premiums in market-based portfolios, meaning your returns fluctuate based on how those investments perform. Unlike fixed annuities, variable annuities offer growth potential but carry higher risk.
Variable annuities provide market-based returns that can fluctuate, while fixed annuities guarantee a fixed interest rate and principal protection. This means variable annuities have higher growth potential but also more risk compared to the stable and predictable income from fixed annuities.
Yes, variable annuities give you the flexibility to choose and change how your premiums are invested among various market portfolios. However, you also bear the investment risk, so your returns depend on market performance.
Generally, yes. Variable annuities tend to have higher fees and expenses compared to fixed annuities due to the investment management and insurance features they include.
Both variable and fixed annuities can be converted into guaranteed lifetime income payments during retirement. However, the amount you receive from a variable annuity can vary based on investment performance, while fixed annuity payments remain steady.
No, unlike fixed annuities, variable annuities do not guarantee your principal. Your investment value can go up or down depending on the market, so there is a risk of losing money.
Variable annuities offer tax-deferred growth, meaning you won’t pay taxes on your earnings until you withdraw them. This can help your investment grow faster over time compared to taxable accounts.
