If you’re looking for a great investment opportunity for your retirement, a variable annuity can open up a world of possibilities for your future. However, there are a number of misconceptions and frequently asked questions about how variable annuities work that can be confusing for most people new to them.
Contacting an independent insurance agent can help demystify these questions and shed light on variable annuities that work for your unique situation.
That being said, it’s important to have a working knowledge to make informed financial decisions. In this FAQ, we’ll look at some of the most important questions about variable annuities, including:
Table of Contents
What Is A Variable Rate Annuity?
What Is A Variable Annuity Contract?
Are Variable Annuities Liquid?
Are Variable Annuities Safe?
Are Variable Annuities Worth It?
Are Variable Annuities Protected From Creditors?
Are Variable Annuities Insured?
What Are The Advantages And Disadvantages Of Variable Annuities?
What Does It Mean To Annuitize A Variable Annuity?
What Is A Living Benefit Rider On A Variable Annuity?
What To Do When A Variable Annuity Matures?
What Is A Group Variable Annuity?
What Is A Variable Annuity Fund?
Can You Lose Money In A Variable Annuity?
What Was The First Variable Annuity To Appear In 1952?
What Is a Variable Rate Annuity?
A variable annuity is a hybrid investment vehicle that contains the features of both securities and insurance. These are generally designed for retirement purposes after individuals have maxed out their 401(k)s and/or IRAs.
As the invested capital appreciates, the annuity provides regular income up to the policy’s set limits which are set and rarely changeable after entering into the contract.
Variable annuities are subject to market risks, as an underperforming market can result in lower premiums. On the other hand, favorable market conditions can lead to higher payouts.
Additionally, variable annuities can provide a death benefit for designated beneficiaries with the remaining funds in the account’s remaining value.
What is a Variable Annuity Contract?
A variable annuity is a legally-binding contract where an insurance company and an investor agree to terms and conditions of the investment. The investor either pays a lump-sum amount or premiums over a period of time, entering into either a deferred payment or immediate payment contract.
This occurs during the accumulation phase, where predetermined limits must be met in accordance with the variable annuity contract. Once the period has elapsed, the contract enters into the payout phase, where regular payments to the annuitant (the investor) are typically made on a monthly basis.
Variable annuity contracts widely differ from company to company. Some offer a wide variety of riders, such as a Long-Term Care (LTC) rider and Guaranteed Minimum Income Benefits (GMIB).
There is also a wide variance in contractual details, particularly which fees are applicable and under which circumstances. For more information, consult an independent insurance agent to help you navigate the fine print.
Are Variable Annuities Liquid?
Variable annuities are liquid, but the degree of liquidity depends on the terms of your contract. In most cases, a policyholder can begin to withdraw funds penalty-free from the annuity once reaching age 59½.
However, if you only need to withdraw a small portion of the annuity’s allocated funds before reaching this age, you may not encounter any penalties. Most companies typically allow this amount to reach 10% of the annuity before being charged a fee.
If you want to withdraw a large portion of the annuity or cancel the contract, you will be charged a surrender fee if you choose to withdraw money beforehand (generally between three to 10 years, which is similar to how a life insurance policy works).
Also, some annuities offer a liquidity option that is triggered by certain events such as an immediate need, most commonly for nursing home care or due to a terminal illness.
Are Variable Annuities Safe?
The answer to this question depends on your definition of “safe”.
- First, every type of investment carries some amount of risk. Variable annuities come with principal risk, where the market determines how well the investment will perform and keep up with yearly inflation. If a mutual fund or other securities do not perform well, the investor has no recourse. Variable annuities enable your money to grow with inflation and how your investments perform. In comparison, fixed annuities lose relative value.
- If you’re looking for safety provided by a company that won’t go under, you should know that variable annuities aren’t insured by the FDIC or any other federal body, which only regulates bank products and has no involvement with the insurance industry. Instead, there are two forms of protection for variable annuities:
- State insurance regulators have guaranty funds that are funded with premium payments from insurers. Essentially, these funds reimburse insurance contract holders who incur losses when insurance companies file bankruptcy. It should be noted that guaranty fund coverage levels vary from state to state. However, most variable annuities are afforded some coverage by guaranty funds.
- The Securities Investor Protection Corporation (SIPC) insures securities, (including variable annuities) that are held in accounts at SIPC member firms up to $500,000 per account owner, per broker house. There is a caveat, however: the SIPC only pays out if the brokerage firm, as opposed to the insurer, files for bankruptcy.
- Investors can provide more safety for the variable annuity by purchasing insurance riders called Guaranteed Minimum Income Benefits (GMIB). GMIBs increase the income value of the account on a yearly basis, even if the underlying mutual funds lose value.
- Variable annuities include life insurance that protects the beneficiaries of the account owner in the event that the owner passes away prematurely.
Are Variable Annuities Worth It?
The answer to this question is dependent on the goals of the investor. Variable annuities are designed to enable investors to provide regularly occurring income that outpaces inflation while providing insurance benefits to protect your assets and your beneficiaries.
Additionally, there are tax-deferment benefits that come via the 1035 Exchange, which allows a policyholder to transfer funds from an endowment, life insurance, or annuity to a new policy without having to pay taxes.
Despite these benefits, there are a large number of fees associated with variable annuities, as well as withdrawals being subject to taxation. For these reasons, you may need the guidance of a financial professional, such as an independent insurance agent.
They can help you decide which insurance companies provide the most favorable rates for your variable annuity while also avoiding unnecessary fees to fit your retirement plans.
Are Variable Annuities Protected from Creditors?
Yes, variable annuities can offer creditor protection. However, you will need to understand the laws of your state of residence to see whether they cover annuities and to what extent your annuity assets are sheltered from creditors. Therefore, if you’re looking to use annuities for creditor protection, it is important to understand your state's laws before making a decision to buy the annuity.
Also, if you decide to use variable annuities for creditor protection, do not wait until financial trouble hits. Instead, take action immediately, as a court could possibly strike down your annuity purchase as it may be determined that you intended to defraud creditors.
Also, variable annuities are partially protected from creditors by federal exemptions. Because bankruptcy law is federal, there are exemptions for certain assets related to life insurance policies and annuity contracts.
Section 522(d)(8) of the Bankruptcy Code establishes an exemption for "any unmatured life insurance contract," with a maximum amount of $12,250 protection in cash value (inflation-indexed).
Furthermore, Section 522(d)(10)(E) extends these exemptions to payments under annuities payable by reason of illness, disability, death, age, or length of service to the extent reasonably necessary for the debtor's support. Bear in mind that these exemptions are relatively limited, so only a few qualifying annuity owners should rely on them for creditor protection.
Are Variable Annuities Insured?
Yes, by both state guarantee funds and the SIPC (see above - “Are Variable Annuities Safe?”).
What are the Advantages and Disadvantages of Variable Annuities?
Pros of Variable Annuities:
- Periodic payments of monthly income for the contract holder’s lifetime
- Death benefit paid to beneficiaries
- Growth relative to the performance of the market that can adjust for inflation
- Not subject to contribution limits
- The money in them grows tax-deferred
- Many states protect them from collections by creditors
- They are exempt from probate
Cons of Variable Annuities:
- They can end up generating significant tax liabilities upon withdrawal
- They usually come with high fees that could outweigh the benefits
- They are so complex that many who own them don’t understand them
What Does It Mean to Annuitize a Variable Annuity?
Annuitizing a variable annuity means that the annuity will convert to a series of guaranteed payments (monthly or quarterly). Variable annuities can be annuitized for a specific period or for the life of the annuitant. It’s important to understand that annuity payments may only be made to the annuitant or to the annuitant and a surviving spouse (via joint-life arrangement).
This option is more geared towards those who want to focus on regularly occurring income in their retirement, but annuitants can arrange for beneficiaries to receive a portion of the annuity balance when they pass away.
What Is a Living Benefit Rider on a Variable Annuity?
As a purchasable optional add-on to an annuity contract, a living benefit rider guarantees a payout to beneficiaries while the annuitant is still alive. This is basically a charge to a variable annuity that helps prevent a policyholder from outliving their income if the annuity performs poorly.
For instance, if the chosen securities originally purchased at $50,000 are only worth $35,000, the living benefit rider will make up for the lost $15,000 when liquidating the account.
What to Do When a Variable Annuity Matures?
When your variable annuity matures, you have several other options to choose from:
- Cash out the account and take a lump-sum withdrawal
- Leave money invested and withdraw periodically or according to a schedule
- Renew the variable annuity with terms and conditions that may remain the same or be modified according to the company and policyholder
- Annuitize, which creates a permanent stream of guaranteed income that could potentially last for the life of the
- Rollover into a new annuity via a 1035 Exchange
What is a Group Variable Annuity?
A group variable annuity is a contract between insurance companies and employers, which in turn offers investment opportunities to their qualified employees as an option for retirement savings.
Essentially, participants contribute to these variable annuities in exchange for future payments to the retiree and/or to their survivors. For these reasons, group variable annuities are sometimes referred to as a “structured pension plan”.
What is a Variable Annuity Fund?
A variable annuity fund is essentially a mutual fund with the insurance benefits of tax-deferment. Investments are made in mutual funds or mutual-fund-type accounts offered by the particular annuity, including:
- Large-cap stocks
- Mid-cap stocks
- Small-cap stocks
- International stocks
- Short-term bonds
- Specialty investments
- Asset allocation
- And more
For examples of variable annuity funds, see Nationwide’s list to give you an idea of what’s available from many insurance companies.
Can You Lose Money in a Variable Annuity?
Yes, there are multiple ways to lose money in a variable annuity, either through:
- Principal risk, where investment declines in value below the amount one invested through poor market performance
- Early termination of the contract, where the insurer will charge fees that reduce the principal amount invested
- Fees in excess of the initial amount invested
What was the First Variable Annuity to Appear in 1952?
For those curious about the history of variable annuities, the first deferred variable annuity was introduced by TIAA-CREF in 1952, which is now known as the CREF Stock Account. This was an addition to the only other annuity structure available, Single Premium Immediate Annuity (SPIA).
Still Got Questions about Variable Annuities?
If you’ve made it this far, congratulations! Variable annuities can be confusing, even for those who currently have policies in place or are seriously considering one in the future. To fully understand how you can maximize your opportunities with variable annuities and how they can be adapted to your unique situation, independent insurance agents can give you the best financial out there.
With decades of experience in financial planning, you can trust these independent agents.
TrustedChoice.com Article | Reviewed by Neel Lane
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