A variable annuity is a type of life insurance and investment product in which the contract’s value fluctuates based on the performance of an underlying portfolio of securities or other index. Unlike fixed annuities that offer a guaranteed return, variable annuities provide the potential for higher returns depending on market performance.
Key Characteristics
- Underlying Securities Portfolio: The investment options typically include mutual funds, bond funds, and money market funds.
- Fluctuating Returns: The value of the annuity can go up or down depending on market performance, similar to other investments in securities.
- Tax-Deferred Growth: Earnings in a variable annuity grow tax-deferred until they are withdrawn.
- Death Benefit: Many variable annuities offer a death benefit to the beneficiaries, which can be a minimum guaranteed amount or the contract value at the time of death, whichever is higher.
Types of Variable Annuities
- Immediate Variable Annuities: Begin payments almost immediately after a lump-sum investment.
- Deferred Variable Annuities: Accumulate value over time before the payout phase begins, allowing for a longer period of investment growth.
Special Considerations
- Fees: Variable annuities often have higher fees compared to other investment products, including administrative fees, investment management fees, and mortality and expense risk charges.
- Surrender Charges: Withdrawals made during the early years of the annuity contract may incur surrender charges.
- Market Risk: As the returns are tied to market performance, they come with inherent risks similar to other securities investments.
Historical Context
Variable annuities first became available in the United States in the 1950s as a way to offer investors a tax-deferred investment vehicle with the potential for higher returns than fixed annuities.
Applicability
Comparison to Fixed Annuities
Advantages of Variable Annuities:
- Potential for higher returns.
- Investment growth tied to market performance.
Disadvantages of Variable Annuities:
- Higher fees and expenses.
- Increased risk due to market volatility.
Related Terms
- Fixed Annuity: An annuity with a guaranteed interest rate and periodic payments.
- Mutual Fund: An investment vehicle that pools money from many investors to purchase a diversified portfolio of securities.
- Tax Deferral: The postponement of taxes on earnings until the money is withdrawn.
- Mortality and Expense Risk Charge: A fee charged for the insurance risk the company assumes under the annuity contract.
Frequently Asked Questions (FAQs)
What is the main difference between a variable and a fixed annuity?
The main difference lies in the return rate. A variable annuity’s return fluctuates with the performance of its underlying investments, while a fixed annuity provides a guaranteed rate of return.
Are there any guarantees in a variable annuity?
Variable annuities often come with a death benefit guarantee, which ensures that beneficiaries receive at least the amount invested minus any withdrawals, regardless of market performance. However, the investment returns are not guaranteed.
What are the typical fees associated with a variable annuity?
Typical fees include administrative fees, investment management fees, mortality and expense risk charges, and possible surrender charges for early withdrawals.
Summary
A variable annuity is a financial product offering life insurance benefits and investment opportunities, tied to the market performance of an underlying portfolio of securities. While offering potentially higher returns compared to fixed annuities, they come with higher fees and increased market risks. Proper understanding and assessment of risk tolerance are crucial when considering a variable annuity as an investment option.
References
- Financial Industry Regulatory Authority (FINRA). “Variable Annuities.”
- U.S. Securities and Exchange Commission (SEC). “Variable Annuities: What You Should Know.”
This comprehensive entry ensures readers understand the core concepts, types, and special considerations related to variable annuities, providing a solid foundation for further exploration into financial products.
