Dealing with Variable Annuities

A variable annuity has a variable rate of return attached to it. In other words, some years can be very beneficial to your annuity, while in other years, you might actually lose money. Much like mutual funds, a variable annuity is connected to various assets within the stock market. But unlike a mutual fund, an annuity is a retirement account, and thus has many more tax advantages than the typical mutual fund investment. If you are looking to grow your money over the long run in order to be better prepared for your retirement years, a variable annuity will more than likely meet your needs.

Variable annuities require a different type of sales license than fixed annuities, so you might have to deal with an investment firm that also sells insurance rather than just a life insurance specialist. While they are still technically life insurance policies, they are also variable accounts, so only a sales professional with the proper credentials will need to sell you your policy. It requires an additional license to sell, so your choices as far as salesmen will be a little bit more limited.

An Important Distinction

Looking Out for the Best Variable AnnuityVariable annuities and mutual funds have a lot of overlap, but they are two very different things. A mutual fund is a managed fund that is comprised of different stocks, cash holdings, money market accounts, and bonds. The composition of the fund will change from time to time in order for the manager to best protect investors from risk and to help them grow their money.

A variable annuity is an insurance product designed to create lifelong income through the retirement years and even provide income to a beneficiary after the original holder passes away, if that’s what is desired. An annuity can be comprised of mutual funds, but not necessarily.

One way to think about this is to think of the annuity as a bucket. Inside that bucket might be a mutual fund, which is still a mutual fund. However, because the mutual fund is inside of the larger variable annuity vehicle, it is subject to the benefits and rules of an annuity, too.

Variable annuities tend to rely on mutual funds quite a bit because they do fluctuate with the market and provide some protection from risk. What your particular variable annuity looks like will depend on the insurance company that you go through and your personal preference.

 Who Benefits?

People who are looking for an investment that will keep up with inflation benefit the most with this type of annuity. This usually equals younger professional folk since they will be contributing a little bit of each paycheck into their policy. The dollar cost averaging method of investing will make a variable annuity much more valuable to a policyholder because this will smooth out the ups and downs of the market over time. This type of investing is also pretty easy: you just keep your contributions steady and timely. By investing a little bit each month regardless of market conditions, you will invest money in good markets and bad, thus making your money average out to the cost of inflation over a long enough timeframe.

The market does fluctuate over time. There will even be periods of time where money is lost consistently over a period of months or longer. Variable annuities But the beauty of the market is that if you take a step back and look at it over the long term, there is steady upward growth. If you invest in a solid variable annuity over a long period of time, you can tap into that long term growth and multiply it thanks to compound interest. This is why variable annuities are usually used by younger people; that long term growth makes them far more appealing than the steady but small returns that a fixed annuity provides.

Disadvantages

Variable annuities have added costs to them that fixed annuities do not. Some might even be as high as 1 or 2 percent of your total investment per year. Because these policies don’t just grow money without any risk, a fund manager must oversee how funds are appropriated, and as a result of this, there are commission and maintenance costs that must be paid. In other words, they require a lot more work than fixed annuities do. In addition to this, there is always the risk that your investment will shrink because of a falling in price of the attached financial assets. If you have a variable annuity that is attached to developing countries, and this asset falls in value, your annuity will also lose value.

Over the long run, variable annuities almost mirror inflation and have the potential to outpace it, but the short term variations can be much different and they can lose money. This makes variable annuities more of a long term investment than their fixed brethren. However, if you look at it over the long run, variable annuities tend to have much more potential than a fixed annuity.

Another disadvantage is the fact that not all companies have the same approach to annuities. Some are much better than others, and they do change from time to time. It’s important to do your research and pick the best one for your particular set of needs.

Is a Variable Annuity for me?

Variable annuities are typically funded a little bit at a time over a long period of time. If you are still working and you already have an IRA or a Roth IRA retirement account, getting a variable annuity in order to help maximize your savings can be a great addition to your portfolio. Variable annuities are not risk-free, but you can usually dictate into what type of subaccounts you want your money divided up within, thus giving you a bit more control and protection over your investment. If you are adverse to risk, you can always invest in safer bonds and blue chip stocks. If you do not mind risking a bit, you can sometimes see greater rewards by investing in riskier assets.

Other things to consider

Public school teachers’ retirement accounts are variable annuities. Defined by section 403(b) of the Internal Revenue Code, teachers, other education professionals, and other state employees contribute a little bit of each paycheck into such an account. Similar to a 401(k) fund, 403(b)s are still considered to be an insurance product even though they are more closely related to a retirement account. If you fit into this category, you probably already have a variable and didn’t even know it.

Whether you already have an annuity or you are thinking of investing in one, you will want to check out the fee schedule before you go any further. With front-loading, or A-share fees, the fee will take money off right from the beginning of the investment’s life. If you put in $100,000 and there is a 2 percent fee, only $98,000 will begin earning interest. You will want to avoid this type of fee for the most part. Instead, look at B-share fees that only penalize you for early withdrawals and allow more of your money to work for you. This allows for compound interest to work in your benefit. This won’t always be the best option for you but speaking to a tax professional and your financial advisor can give you a better idea of which of these options will benefit you the most.

Final Thoughts

Buying a variable annuity is a good long term investment for most people, but not for everyone. They typically have lower fees associated with them than traditional mutual funds do, but not always. And because these two products are so closely related in other aspects, it’s a surprise that variable annuities don’t get more policyholders. Variable annuities also grow tax deferred, giving them yet another advantage over the typical mutual fund.