Types of Variable Annuities
Variable annuities are insurance company-backed investment vehicles that allow individuals to establish a guaranteed future income, typically for retirement, while also deferring taxes on the gains accumulated. They generally differ from other kinds of investment vehicles commonly used to fund retirement, such as similarly tax-deferred 401(k) plans and IRAs, in that investors can contribute as much money as they want without limit.
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Types
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Two main classes of variable annuities exist: deferred and immediate. The immediate variety allows investors to make one lump payment, after which they begin to receive benefits after a set short period of time, such as two months.
The deferred variety falls into two subcategories: periodic-payment deferred annuities and single-premium deferred annuities. The latter are similar to immediate variable annuities in that investors make one lump payment. However, they do not begin to receive benefits until after a much larger interval of time. Periodic-payment deferred annuities also do not pay benefits until a later date, but investors make regular payments instead of just one.
Some companies divide variable annuities further into non-qualified and qualified categories. The former refers to variable annuities that investors purchase independently, while the latter are acquired through retirement savings plans offered by employers.
Features
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With the exception of the immediate type, variable annuities have an accumulation phase, during which investors make payments to their account, and a payout phase when the backing insurance company disseminates benefits.
Another prominent characteristic of variable annuities is an investor's option to choose the death benefit and how it will be paid to beneficiaries, either as the entire amount in the account or a pre-set minimum, as well as a stepped-up death benefit of a larger amount of money than the account has.
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Time Frame
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Investors in all variable annuities must adhere to strict time and age requirements for making withdrawals if they want to avoid IRS and insurance company fees. Money withdrawn before the age of 59-and-a-half usually results in a 10 percent IRS tax penalty, and insurance companies customarily charge a hefty surrender fee of six percent or more for other withdrawals made before a set time frame, such as seven years. However, surrender fees frequently decrease a certain percentage annually as the surrender period increases.
Benefits
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Variable annuities can be attractive for investors who like that they won't have to worry about paying income tax on annuity earnings until they begin receiving benefits or make a withdrawal. Another perceived advantage is the common guarantee that investors will never receive less than the initial principal amount, even if the annuity investments decrease in value.
Considerations
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Variable annuities come with numerous fees, ranging from surrender charges to insurance company administrative fees and IRS early withdrawal penalties. Another major consideration is how much tax must be paid when investors or their beneficiaries start receiving benefits: a whopping 10 percent to 35 percent, depending on their tax bracket, as opposed to the typical 5% to 15% for other kinds of investment benefits.
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