Are Variable Annuities Good Investments?
Variable annuities are special insurance contracts designed and sold by life insurance companies. An annuity guarantees an income to you during retirement. These payments may be held inside of an annuity, however, and deferred for your entire life if you so choose. When deciding on whether to choose a variable annuity, make sure you understand how they work and whether they are right for you.
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Function
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Variable annuities function by letting you invest your savings into mutual funds. Administrative fees are then deducted from the annuity every month, or every year, to pay for maintenance of the account. Mutual funds are a collection of stocks, and sometimes bonds, inside of the annuity account. The annuity account also serves as the death benefit of the annuity policy. Your beneficiaries will receive whatever the account balance (your contributions plus investment income) is at your death. Contributions to variable annuities are after-tax.
Significance
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The significance of a variable annuity is that you are combining insurance with investing while allowing your investments to grow on a tax-deferred basis. In addition, when the fund manager buys and sells stocks within the fund, you will not pay capital gains tax as you would if you owned fund shares outside of an annuity. When you begin to make withdrawals from your annuity it will be taxed as ordinary income.
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Benefit
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A variable annuity allows your retirement savings to grow over time without taxes eating into your income. This can provide you with a larger nest egg, in the long run, over investing in mutual funds outside the annuity. Additionally, while the annuity provides a death benefit for your beneficiaries, unlike standard life insurance or a fixed annuity, you retain full control over your investments within the annuity. You can often switch mutual funds with no additional fees being charged and can elect to receive a guaranteed income for life from the contract if you choose. By annuitizing your variable annuity -- converting your annuity to a lifetime periodic income -- during your lifetime, you can spread out the payment of taxes. These payments represent mostly a return of investment principal with a small amount of interest added to the payment.
Disadvantage
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The disadvantage to a variable annuity is that the fees may be high. Variable annuities represent a convenient way to invest, while providing insurance protection at the same time. But, the annuity account balance could be negatively affected because of the fees. The fees are charged whether you make money or lose money. Another disadvantage with any annuity is that while they can provide a lump-sum death benefit for beneficiaries, unlike most life insurance policies, all the gains on the annuity investments will be taxable to the beneficiaries as income.
Considerations
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Before investing in a variable annuity, consider whether you have the investment experience to choose your own mutual fund investments. You may have some help from the insurance company, but you will generally have to make your own decisions when it comes to investing in the annuity. Alternatively, you can invest in a fixed annuity. Fixed annuities pay a fixed rate of return that may be lower than your variable annuity over the long-term. However, you won't have to manage your own investment portfolio.
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