Variable annuities are a popular option for retirement planning. While they are a complicated mix of insurance and investments, what they do is simple. Variable annuities build wealth and create lifetime retirement income.
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Which of the following are true about variable annuities? (spoiler alert ... none of them)
Myth #1: Variable annuities are only for retirees
It’s true that the concept of an annuity is to provide lifetime income. Variable annuities can also help you save for retirement. Variable annuities are an affordable way the average investor can take advantage of professional money management and diversification. Variable annuities usually have a wide selection of investment options to choose from. Stock funds, bond funds, real estate, as well as other asset classes are often on the menu. Mutual funds, of course, offer these options as well, so why is a variable annuity different?
Variable annuities are tax-deferred investment vehicles. There is no tax on capital gains and dividends until money is distributed. For investors who regularly rebalance their portfolios between asset classes, tax deferral is important. That's because there is no tax when one investment is sold and another purchased. So instead of the money going to Uncle Sam, it stays in your account and continues to grow.
If you have "maxed out" your contributions to your employer's retirement plan or IRA, a variable annuity can be a good alternative to supplement your savings.
Myth #2: All variable annuities are the same
There are three common types of variable annuities. Each one has specific features to suit different investor goals.
Protection focused variable annuities are the most common on the market. These variable annuities offer minimum death benefits, and a menu of optional riders such as:
- Guaranteed minimum income benefit (GMIB) rider provides a minimum amount of lifetime income when they retire regardless of what the account value is. The minimum income is based on the original investment accumulated at an interest rate specified in the policy. Once the option is selected, the owner has no access to policy values.
- Guaranteed lifetime withdrawal benefits (GLWB) rider provides a minimum amount of lifetime income when they retire regardless of the account value. Unlike the GMIB, the owner does have access to the account values. Withdrawing money in excess of the guarantee will reduce or eliminate the minimum income.
- Guaranteed minimum accumulation benefits rider guarantees a minimum account value regardless of investment performance. The minimum is usually 100% of the purchase payments after a 7-10 year holding period.
- Enhanced death benefit riders protect beneficiaries from down markets. The standard death benefit of a variable annuity is the account value. Enhanced death benefits provide a guaranteed minimum death benefit.
Investment focused variable annuities are low-cost options. They don't offer riders, and the death benefit is the account value. These are for investors who regularly make changes to their portfolios and want to maximize the tax advantages of variable annuities.
Indexed linked variable annuities feature downside market protection.
Myth #3: Variable annuity fees are exorbitant
Variable annuities are a combination of insurance and investments. Variable annuity fees and expenses with optional riders can be upwards of 3%. The question to ask is are the protection features worth the cost? That's why it's important to understand what the riders do and how they fit into your retirement plan before you make the decision to buy.
For investors who are not interested in most of the protection features, there are low-cost options available, some at less than 1%. Index linked variable annuities don't have fees and expenses.
Myth #4: When I pass away, the insurance company will keep my money
What the beneficiaries receive depends on the death benefit and income options that you select. If you pass away while the variable annuity is still accumulating money, your beneficiaries will receive at least the account value. If your annuity has a guaranteed minimum death benefit or enhanced death benefit rider, the proceeds will be the greater of the death benefit or the account value.
If you pass away while you are receiving income from the annuity, your beneficiaries will receive proceeds based on the option that you select. The only option that pays nothing to beneficiaries is "life only". The "life only" pays income for life, and it is the highest payout of all the options. The "life only" option can pay for the longer of two lives, usually spouses.
Other income options guarantee 10 or 20 payments, or will refund an unused balance. Variable annuity optional income riders generally pay the balance of the account value to the beneficiaries.
Variable annuities are very flexible. You can select a lifetime income option that best suits your retirement and legacy plan goals.
Myth #5: If I need money, I won't be able to access it
Variable annuities are long-term investments. They are not a good option if you need access to the money on a regular basis. There is a 10% penalty tax on distributions before age 59 1/2, and there are usually surrender penalties for 5 to 10 years.
That said, variable annuities allow for an annual withdrawal up to 10% of the account value surrender penalty free.
Myth #6: I can easily get income from my retirement accounts
You can always take income from your retirement accounts. In fact, you have to take distributions beginning at age 72 (required minimum distributions). The question is can you create an income that you can't outlive? There are only three ways to do that. Social security, pensions, and annuities.
Markets, interest rates, inflation and longevity all have an impact on planning for your retirement income. That's why variable annuities are often part of a well-designed retirement plan.
Variable annuities are a retirement planning tool. They're designed to build wealth and create lifetime retirement income. Is one right for you? That depends on your retirement and legacy plans. Independent insurance agents are annuity professionals. They can help you make a smart choice.
TrustedChoice.com Article | Reviewed by Jeffrey Green
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