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Sat Dec 9, 2023
A variable annuity is a contract between policyholder and an insurance company under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date.
You purchase a variable annuity contract by making either a single purchase payment or a series of purchase payments.
A variable annuity offers a range of investment options. The value of your investment as a variable annuity owner will vary depending on the performance of the investment options you choose. The investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three.
Payment till Lifetime: Variable annuities let you receive periodic payments for the rest of your life (or the life of your spouse or any other person you designate). This feature offers protection against the possibility that, after you retire, you will outlive your assets.
Death benefit before Vesting: Variable annuities have a death benefit. If you die before the insurer has started making payments to you, your beneficiary is guaranteed to receive a specified amount—typically at least the amount of your purchase payments. Your beneficiary will get a benefit from this feature if, at the time of your death, your account value (value of your fund) is less than the guaranteed amount.
Tax-Deferral: Variable annuities are tax-deferred. That means you pay no taxes on the income and investment gains from your annuity until you withdraw your money. You may also transfer your money from one investment option to another within a variable annuity without paying tax at the time of the transfer. When you take your money out of a variable annuity, however, you will be taxed on the earnings at ordinary income tax rates rather than lower capital gains rates.
In general, the benefits of tax deferral will outweigh the costs of a variable annuity only if you hold it as a long-term investment to meet retirement and other long-range goals.
A variable annuity has two phases: an accumulation phase and a payout phase.
During the accumulation phase, you make purchase payments, which you can allocate to a number of investment options. For example, you could designate 40% of your purchase payments to a bond fund, 40% to a U.S. stock fund, and 20% to an international stock fund.
The money you have allocated to each mutual fund investment option will increase or decrease over time, depending on the fund’s performance.
In addition, variable annuities often allow you to allocate part of your purchase payments to a fixed account. A fixed account, unlike a mutual fund, pays a fixed rate of interest. The insurance company may reset this interest rate periodically, but it will usually provide a guaranteed minimum (e.g., 3% per year) ·
During the accumulation phase, you can typically transfer your money from one investment option to another without paying tax on your investment income and gains, although you may be charged by the insurance company for transfers. o However, if you withdraw money from your account during the early years of the accumulation phase, you may have to pay “surrender charges,” which are discussed below. In addition, you may have to pay a 10% federal tax penalty if you withdraw money before the age of 59½.
Example: You purchase a variable annuity with an initial purchase payment of $10,000. You allocate 50% of that purchase payment ($5,000) to a bond fund, and 50% ($5,000) to a stock fund. Over the following year, the stock fund has a 10% return, and the bond fund has a 5% return. At the end of the year, your account has a value of $10,750 ($5,500 in the stock fund and $5,250 in the bond fund), minus fees and charges.
At the beginning of the payout phase, you may receive your purchase payments plus investment income and gains (if any) as a lump-sum payment, or you may choose to receive them as a stream of payments at regular intervals (generally monthly).
If you choose to receive a stream of payments, you may have a number of choices of how long the payments will last.
Under most annuity contracts, you can choose to have your annuity payments last for a period that you set (such as 20 years) or for an indefinite period (such as your lifetime or the lifetime of you and your spouse or other beneficiary).
During the payout phase, your annuity contract may permit you to choose between receiving payments that are fixed in amount or payments that vary based on the performance of the mutual fund investment options.
The amount of each periodic payment will depend, in part, on the time period that you select for receiving payments.
Be aware that some annuities do not allow you to withdraw money from your account once you have started receiving regular annuity payments.
In addition, some annuity contracts are structured as immediate annuities, which means that there is no accumulation phase and you will start receiving annuity payments right after you purchase the annuity..
A common feature of variable annuities is the death benefit. If you die, a person you select as a beneficiary (such as your spouse or child) will receive the greater of:
(i) all the money in your account, or
(ii) some guaranteed minimum (such as all purchase payments minus prior withdrawals).
Some variable annuities allow you to choose a “stepped-up” death benefit. Under this feature, your guaranteed minimum death benefit (GMDB) may be based on a greater amount than purchase payments minus withdrawals. For example, the guaranteed minimum might be your account value as of a specified date, which may be greater than purchase payments minus withdrawals if the underlying investment options have performed well. The purpose of a stepped-up death benefit is to “lock in” your investment performance and prevent a later decline in the value of your account from eroding the amount that you expect to leave to your heirs.
This feature carries a charge, however, which will reduce your account value.
Variable annuities sometimes offer other optional features, which also have extra charges. One common feature, the guaranteed minimum income benefit (GMIB) , guarantees a particular minimum level of annuity payments, even if you do not have enough money in your account (perhaps because of investment losses) to support that level of payments.
Other features may include long-term care insurance (LTCI), which pays for home health care or nursing home care if you become seriously ill.
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