An annuity is a stream of income. A purchaser makes periodic or one-time payments during the “accumulation phase” of an annuity so that at some point in the future they can trade those payments in for a stream of income. The aspect of an annuity which makes it “variable” as opposed to “fixed” is the fluctuating performance of the sub-accounts which they invest in. Typically, annuity sub-accounts are invested in mutual fund-like holdings which can own stocks, bonds, and alternatives. The total contract value of your annuity will vary depending on the performance of the underlying investments. There is a lot of chatter about the positive and negative aspects of investing in variable annuities because of their complexity and potential expense. I will explain further below:
One of the benefits to owning an annuity is the predictability which it offers to those planning for retirement. For many retirees and soon-to-be retirees, creating future budgets can be a difficult task as they often can’t anticipate what their financial needs will be. Related to that, trying to fund retirement by withdrawing each year from a lump sum can be a confusing and stressful task. Can you withdraw 4% or more each year without depleting your principal? How can we predict what the inflation rate will be? Perhaps at the top of people’s minds, how does one guarantee that they won’t outlive their assets? These are the sorts of concerns that an annuity will attempt to bundle up and sell a solution to through one carefully crafted financial product.
Most variable annuity contracts have various add-ons (often referred to as riders) which can be included at an additional expense to address investor’s specific needs. Below is a list of both standard features and add-ons which you may commonly find with variable annuity contract.s
Death Benefit – The annuity will offer a payment to your spouse or other named beneficiary when you die. They will generally receive either the sum of your purchase payments or the remaining contract value- whichever is higher- when you die. While death benefit is a standard feature on most annuity contracts, you will pay for this through your insurance expenses on the contract. Some contracts offer additional “stepped-up death benefits” as well which may guarantee even higher death benefit payments (at an additional expense) if minimal withdrawals are taken or the market performance of the underlying investments is favorable.
Accumulation Riders – Most variable annuities offer various locks and step-ups to those who wait before taking distributions from their annuities. For example, if you are 55 and purchase an annuity which pays you 5% for life at age 65, your goal is to get that contract value as high as possible before you begin your income stream. The annuity may offer you to take that 5% off the contract value OR some other guaranteed amount–whichever is higher. Some contracts offer 5% or 6% credits to the income base in each year in which a withdrawal hasn’t been taken. These features ensure that the annuitant is getting back more than just the original principal through their withdrawals.
Guaranteed Minimum Income Benefit – A type of option that annuitants can purchase for their retirement annuities. This specific option gives annuitants the ability to protect their retirement investments against downside market risk by allowing the annuitant the right to withdraw a maximum percentage of their entire investment each year until the initial investment amount has been recouped.
Long-Term Care Insurance – Many variable annuity contracts now offer long-term care rider add-ons which allow for increased or advanced payouts in the event the annuitant qualified for long-term care. This won’t be as comprehensive as what you’d expect from a full long-term care insurance contract, but it could be good way to get some hybrid benefit.
This is the basic story with variable annuities. Are they worth it? For many people they are an ideal financial product. For others, particularly true do-it-yourself investors, they might try to unbundle the product and their their own through purchasing individual insurance contracts for the death benefit protection and building low-cost brokerage accounts with individual bonds and dividend-paying stocks for the income.
Like everything else in one’s financial life, you’ll want to assess your individual needs, time horizon and risk tolerance to figure out what is best for you.
As always, feel free to e-mail me with all questions and comments.
Russell Bailyn
Premier Financial Advisors, Inc
14 E 60th Street, Suite 402
New York, NY 10022
Note: This article is for informational purposes only. It does not represent a solicitation or endorsement to buy any particular financial product. There are risks inherent to investing and you should speak with a financial professional prior to making any decisions.
Variable Annuities are long-term investments designed for retirement. Withdrawals taken prior to age 59 ½ may incur a 10% federal tax penalty. Many variable annuities offer optional riders for an additional charge. These riders are subject to various age, income, and investment restrictions and limitations. Please consult the prospectus for details.
Riders are optional add-ons that annuity buyers can choose, usually at extra cost. The two most popular types of variable annuity living benefit riders are guaranteed minimum withdrawal benefits (GMWBs) and guaranteed minimum income benefits (GMIBs). GMWBs guarantee to return 100% of the premium paid into the contract through a series of annual withdrawals. GMIBs establish a floor of future retirement income into which the contract can convert at the holder’s option. Rider benefits can vary by state, and not all riders are available in every state.
Variable annuities are sold by prospectus. For more complete information about underlying sub-account investment objectives, risks, charges, limitations and expenses, consult the prospectus which may be obtained from your financial advisor or the investment company. Please carefully read the prospectus before investing or sending money.
Securities offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Financial Planning offered through First Allied Advisory Services & Premier Wealth Advisors, Inc. Premier Wealth Advisors, Inc is a Registered Investment Advisor. First Allied Securities & Premier Wealth Advisors, Inc. are not affiliated entities.