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Exploring Variable Annuities: Are They Right For You

by Annie Davis (writer), , March 25, 2014

A variable annuity is a safe investment vehicle that many people use for various reasons.

In most cases, people choose variable annuities as a means to safely grow money for income during retirement. They have the potential to give added financial security to one's golden years while simultaneously safeguarding money already invested. However, combing stock market exposure with investment safety does come at a price. Variable annuities may or may not be right for you and your situation. Here are a few things to consider before you begin investing.

Variable Annuity Basics

The most common goal investors have when opening a variable annuity account is to have a steady stream of income during retirement to supplement social security and IRAs. You invest money via purchase payments, which you can then allocate to a variety of sub-accounts comprised of varying balances of stocks, bonds, ETFs and mutual funds. You can be as aggressive or conservative as you like, opting to go bullish with high-risk/high-reward stocks all the way down to the safe harbor of the bond market. What makes variable annuities different from a mutual fund is that you're guaranteed at least your purchase payments when you decide to cash out, even if your portfolio shrinks in size. Next, we'll explore the pros and cons of annuities, so you're aware of everything before you make the investment.

Benefits of Variable Annuities

There are three significant benefits to variable annuities. First, they give you the option to receive indefinite payments for the rest of your life, avoiding the worry that you may outlive your nest egg. Second, you can appoint a direct beneficiary in case you die before you begin receiving payments, at which point your beneficiary will receive either the sum of your purchase payments or the current value of your account, whichever is greater (minus fees). The third and probably most popular benefit of variable annuities is that they're tax-deferred. Best for long-term strategies, the tax convenience of variable annuities mean you won't have to pay Uncle Sam a dime until your begin making withdrawals, much like a 401(k) or IRA. Keep in mind, however, that you will be levied regular income taxes, and not capital gains taxes, when you make your withdrawals.

Downsides of Variable Annuities

So far, variable annuities seem like a good idea: They allow you to grow wealth tax-free, will sustain you indefinitely, and guarantee you'll receive at least what you put in. However, there's no such thing as a free lunch—all of these perks come at a price. You'll pay what's known as a surrender charge if you decide to pull your money early; Most variable annuity contracts will take surrender charges if you withdraw money in a pre-determined period after you first began making purchase payments, also known as the surrender period. Another charge is known as expense risk. Since the insurance company is taking a risk by investing in stocks and bonds, they'll normally charge an annual fee equal to a small single-digit percentage of your account balance. You will also be responsible for paying administrative fees and costs associated with mutual funds. Additional benefits related to the payout of death beneficiaries, disability care insurance and additional safeguards all come at a price as well, so be sure to review all contingencies with the insurance broker before you set up your annuity.

Remaining Questions and Resources

By design, a variable annuity is a long-term investment and should not be entered on a whim. Do your due diligence and ask yourself what you're looking for most in a variable annuity. Is it the fixed-income financial security for retirement? The peace of mind knowing your family will be taken care of? Exposure to gains in the stock market? Write down every consideration you might have for the future of you and your money. Also be sure to review the insurance broker's prospectus before you open up an account. Resources at FINRA and the National Association of Insurance Commissioners offer plenty of helpful non-biased information and advice with regards to the annuities industry.

Like all investment vehicles, variable annuities are full of pros and cons. Careful analysis of your life situation and the insurance company's policy will help you make an informed decision.

About the Writer

Annie Davis is a writer for BrooWaha. For more information, visit the writer's website.
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