A variable annuity is an insurance contract where the insurer agrees to make periodic payments to you in the future. You can purchase an annuity by making a one-off purchase payment or a series of purchase payments to the insurer.
An annuity has two phases: the accrual of savings phase, during which you make payments into the policy and accumulate tax-deferred investment income; and the payout phase, where you receive periodic payments from the insurance company for the life of your life or your spouse’s life. With a variable annuity, the insurer typically invests your money in mutual funds, which are professionally managed funds that can invest in stocks, bonds, money market instruments, or a combination of all three.
Variable annuities are probably second only to variable life insurance in terms of complexity. They are similar to their fixed and indexed cousins in that they are issued as contracts that grow tax-advantaged regardless of whether they are accepted into an individual retirement account (IRA) or other tax-advantaged retirement plans.
There is a 10 per cent payout penalty for payouts made before the policyholder reaches the age of 59, with certain exceptions for death, disability or other factors. However, variable contracts are unique in that they offer a preselected group. of mutual fund sub-accounts to which you allocate the premiums you pay.
Fund values rise and fall with the markets, with no capital guarantee. Most variable products also contain additional life and death clauses that guarantee a minimum value of the income stream. But even this information is not enough to make an informed purchase decision. You also need to know the pros and cons of these unique products.
Advantages
- Unlimited contributions
As mentioned above, there is no limit to the amount of money that can be paid into a variable annuity. Because of this, they are popular with wealthy investors seeking tax-havens. (Most companies set a limit on initial purchases.
- Insurance protection
Most variable contracts today offer a range of life and death benefits that promise a guaranteed stream of income or a minimum account value. Living Benefit Riders pay a guaranteed income stream based on a hypothetical guaranteed sub-account growth rate. You will continue to receive this payment even if your sub-accounts do not achieve this growth rate.
- Tax deferral
Like all other forms of pensions, variable pensions grow year over year on a tax-deferred basis. Distributions are taxable in the year they are paid.
Disadvantages
- Poor cost basis
Unlike stocks or other securities, the cost basis of variable annuities does not increase when inherited. Beneficiaries pay taxes on the total value of the contract that has grown since the date of original purchase.
- High fees
Variable annuities are one of the most expensive financial products on the market. They come with myriad fees and charges, including mortality and expense fees, mutual fund sub-account administration fees, contract maintenance fees, and other miscellaneous costs. Some contracts charge transaction fees after a certain number of transactions have been made within the contract
