A flexible premium variable annuity is a contract between an individual and an insurance company that is intended to be a long-term investment to generate income for retirement. It has numerous options that can be tailored to each investor's unique needs and also has the potential for growth. For someone who has already contributed the maximum to her 401(k) and IRA, a variable annuity can be an excellent addition to her retirement plans.
All annuities have two phases: the premium accumulation phase and the payout phase. For the premium accumulation phase, the payments can be either one lump-sum payment, or they can be a series of payments adapted to the investor's available cash flow. Flexible premium variable annuities allow the investor to make premium payments on either a predetermined fixed schedule or make varying amounts as funds become available.
Variable annuities invest the annuitant's monies into a family of mutual funds. These funds include a stock fund, a bond fund and a money market account. Depending on his risk tolerance and expectations of the future direction of the markets, the investor can allocate his money amongst these funds. Variable annuities do not have any guarantees for a minimum return.
Earnings in variable annuities are tax-deferred. The investor does not pay any taxes until withdrawals begin. However, he will pay taxes at ordinary income tax rates instead of the lower capital gains rate.
While variable annuities have the potential for gain, they also have the potential for loss. When an investor has chosen to have his future income payments tied to the value of the funds, there is the possibility that these payments will vary and may not be enough to cover his retirement needs.
Even though variable annuities are considered securities and regulated by the Securities and Exchange Commission, they do not carry the guarantee of any federal agency, such as the FDIC. They are only as good as the financial strength of the insurance company that sells them. Investors can check the ratings of the insurance companies with Moody's, Fitch's and A.M. Best and only deal with the highest rated ones. Most states have a special annuity fund that provides some protection to investors in the event of the bankruptcy of an issuing insurance company.
Variable annuities have a variety of fees. These include mortality and expense charges, and administrative costs that can add up to 2 to 3 percent annually. Any additional options, such as death benefits and rights of survivorship, carry additional costs. Penalties, known as surrender fees, for early withdrawals of funds are substantial and can range from 7 to 10 percent within the first 10 years of an annuity.