What, When, and Why.
What…The Basics: An annuity is, quite simply, a stream of payments, over a given period of time. One example: the lottery, which (if you win) you can choose in a lump sum payment or as an annuity—a stream of payments over a specified number of years.
A variable annuity is a long-term contract between investor and insurance provider. In a variable annuity, your account rises and falls based on underlying investment options—but unlike mutual funds, stocks, or other types of investments, a variable annuity also has a “protection” side, typically called living benefits and/or death benefits.
Variable annuities are available from a variety of insurance companies and are usually broken down into two phases of investment:
1. Savings: Earnings (due to underlying investment performance) accumulate tax-deferred.
2. Income and Distribution: Investors have access to a guaranteed stream of income that continues for the balance of their lives.
Why Buy A Variable Annuity?
Like a well-managed mutual fund or separately managed account, the underlying investments of a variable annuity are chosen to perform well in various market conditions. The difference? Variable annuities often carry larger fees, to cover the “protections” and guarantees—guarantees that mutual funds do not offer.
Variable annuities have different types of benefits, including income benefits, withdrawal benefits, and more—all of which affect the amount of your guaranteed balance or the timetable in which you will have access to your funds. The types of benefits that you choose depend on your situation or your reasons for investing in an annuity—and that is why you should discuss the investment with a qualified advisor, who can compare several different options from different companies.
Who Buys A Variable Annuity?
Variable annuities are a complicated investment and before you purchase or invest in a VA you should request a prospectus and “kick the tires” with your financial advisor to make sure it is the right option for you. It can be the right option if you are looking to build a tax-deferred source of income, and benefits such as a death benefit are worthwhile if you are seeking to leave a stream of income or lump sum payment to a dependent (as an estate planning tool).
Variable annuities are a good long-term investment tool. The guarantees, especially in volatile markets, can provide a level of security especially for those who are counting on a stream of income as they retire that is dependable. They are rarely appropriate as a short-term investment. They can be an excellent source of additional retirement funds beyond an IRA or pension—but because they share similar tax-deferred savings features as an IRA, are rarely appropriate as part of your IRA savings.