- Variable annuities are also known as "mutual funds in an insurance wrapper." It combines some of the characteristics of a fixed annuity with some of the benefits of owning mutual funds. Investor pay a premium to the insurance company, similar to the one that they pay for an annuity, and the insurance company then invests the premium in sub-accounts.
- A variable annuity allows an investor to make tax-deferred retirement investments that are larger than those allowed under IRA or 401k plans. There is also a good bit of freedom to move money around within the sub-accounts of a variable annuity. Like all annuities, the variable annuity is intended to provide a guaranteed fixed payment, typically for a pension.
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There are a variety of downsides to variable annuities, despite the GMWB that guarantee investors eventually getting their money back. First, like all annuities, they guarantee retirement income for life, but these products are calculated by insurance companies so that the insurance companies makes money, not the investors. If you die at or ahead of the lifespan curve, the insurance company keeps the remainder of your annuity capital. You only truly make out if you die beyond the predicted lifespan curve.
Annuities are also typically loaded with fees. There is a commission for the sale of variable annuities (at least 5 percent), annual administrative fees that chip away at profit accumulation (between 1.5 to 2.5 percent is the norm), and finally the surrender charge. The surrender charge is a fee paid when the annuity begins to pay out, is charged every year for the first several years, starting high and declining each year until it reaches zero. An example would be to charge a surrender fee of 8 percent on payments the first year, 5.5 percent the second year, and declining by 1.5 percent each year until the percentage drops below zero and ceases to be active. - This is the insurance wrapper on your investment. What the Guaranteed Minimum Withdrawal Benefit (GMWB) does is protect the investment against market risk by guaranteeing the annuitant the right to withdraw a percentage of their entire investment each year until entire the initial investment amount has been recovered. For example, if you purchase a variable annuity for $100,000, and a slump in the stock market reduces the value of the investment to $85,000, with a GMWB of 10 percent, you will be able to withdraw $8,500 (10 percent of the actual value of the account) each year until the entire $100,000 (the guaranteed investment) is recovered.
- There are other forms of guarantees for variable annuities beyond the GMWB, with the GMWB simply being the most popular form. Examples include guarantee of the maximum anniversary value, which looks back the account values on the annuity's anniversary dates, and guarantees receipt of the highest value; the roll-up of the premium, or the guarantee of a minimum payment regardless of the investment value; or the guarantee of either the GMWB or the roll-up of the premium, whichever is higher.
