Explain variable annuity why is it different to other types of annuities?
Variable are legal contracts between insurance companies and people, where the insured is paid periodically from a predetermined date. It is useful as part of a retirement plan or investment. The investor can either pay a series of payments or a lump sum amount to the insurer.
The person insured is offered various options for investments. However, the most common option is mutual funds. This means investing in money market, stock, bonds or a combination of these. The investment value depends on the investment options that are chosen.
There are various types of annuities available in the market. Each has its own set of costs and features. Immediate and deferred annuities are the two basic forms of annuities.
In case of an immediate annuity, the payouts are provided at once. The payouts depend on the contract terms, and can continue for life or a certain period of life.
Deferred annuities are of two basic types, fixed and variable. In case of a fixed annuity, a guaranteed interest rate is provided over a specific period that varies from 1 to 5 years. Where variable annuities are concerned, the interest rate depends on the value of the underlying investment and can change according to it. For investment purposes, variable annuity investors can choose from money market funds, bond and stock for diversifying portfolios or managing risk.
What protection or benefit does it provide?
The following are some of the common available benefits of variable annuities.
Guaranteed Death Benefit: If the investor dies before benefits of the annuity begin to get paid, then the beneficiary named in the contract receives a death benefit. Different companies or contracts have their own way of determining death benefits. However, in general the beneficiary receives the invested amount or the value of the contract’s most current policy anniversary statement, whichever amounts to a greater value. The guaranteed death benefit gives peace to an investor. He or she knows that the money will fall in the correct hand in the case of unforeseen circumstances
Guaranteed Earning Increase Death Benefit: This option enables the beneficiary to receive the higher of an investor’s account value or investment amount. In addition to this, there is a predetermined annual increase that takes place on the investor’s death.
Guaranteed Minimum Income Benefit: Irrespective of how the bond or stock market performs, when the annuity is annuitized this option guarantees a minimum payment. The investor’s investment is compounded by a predetermined rate in order to calculate the guaranteed future payment.
Guaranteed Minimum Withdrawal Benefit: The main idea behind this is that investors can withdraw a maximum percentage of their total investments each year for a specific period until hundred percent of the investment has been recovered, irrespective of market performance.
Guaranteed Lifetime Withdrawal Benefit: This guarantees an investor a minimal withdrawal amount throughout his or her lifetime. The contract does not have to be annuitized and this benefit comes irrespective of the subaccounts performance.
Guaranteed Minimum Accumulation Benefit: With this, the investors are allowed to protect their principal. This happens either with the acceptance of the annuity company’s guaranteed return during a specific term or by locking in growth.
What are the advantages?
Variable annuities have quite a few advantages. Let us take a look at some of them.
Flexibility: Decision about the amount of money to be invested and its allocation for investment options is in the hands of the investor. A person can also decide when to start taking income. All this is possible because the annuity is nonqualified.
No limits on contribution: As long as the products chosen are within the guidelines, the investors can invest as much and as many times they want to.
Rebalancing and tax free transfers: In order to achieve long term goals, the investor can transfer between investment options or rebalance. Though some transfer limits may apply, but on the whole there are no current tax consequences.
An income payout option for life: This is an important benefit provided only by annuities. So there is no reason to fear the fact, that the investor will outlive the income.
Flexibility in withdrawal options: Various withdrawal options are provided by variable annuities. However an important point should be noted here, any optional benefits as well as the value of the death benefit will get reduced by this. Also, income taxes are levied on distributions and withdrawals. A ten percent federal tax penalty along with withdrawal charges can be applied if these are taken before the investor reaches the age of 59½.
What are the fees and costs and how is it charged?
There are two types of fees associated with variable annuities. These include the annuity contract cost and the variable insurance funds expenses that are inclusive in the contract itself.
The annuity contract charges include the administration fees that are a fraction of an investor’s annuity assets and are usually a flat contract maintenance annual fee, and an ongoing asset based mortality and expense fee. These charges are subtracted from the investor’s annuity contract value.
Investors are charged a certain amount of their annuity contributions if they withdraw the money in the starting years of the contract. Upfront sales load are usually not charged. This is known as a contingent sales charge.
Certain annual operating expenses are levied on variable insurance funds. These include shareholder mailing cost, distribution fees, management fees and other miscellaneous costs.
What are the risks?
The investment characteristics of the variable subaccounts are different. The investors’ shares may fluctuate and can be worth more or less their original cost. This is because it depends on the fluctuation of the investment return and principal. Therefore, an investor should try to invest only in those funds that are consistent with related risk tolerance levels and investment objectives.
Also if an investor dies prematurely when the payment annuitization has begun, the insurance company can forfeit the account balance.