Variable Annuities Life Insurance
A variable annuity is a long-term contract between an investor and an insurance company, in which the investor gives the insurance company a certain amount of money to invest. The insurance company promises to give him back the money plus a predetermined amount of earnings on that investment at a future date.
A variable annuity is a registered security, so a prospectus must be given to the investor. The prospectus will describe the various investment options available and any applicable fees and charges. Unlike that of a fixed annuity, the performance of a variable annuity is determined by the performance of the underlying stock investments. There is a significant element of risk.
The Features of a Variable Annuity
Premium flexibility – either lump sum or periodic contributions
Investment control – You can take advantage of emerging trends in the market
Liquidity – You may receive a distribution of up to 10% of the value each year without penalty
Term – They can be short (under 5 years), medium (5-10 years) or long-term (10+ years)
Tax-deferral – Earnings grow tax-deferred until they are withdrawn
Contributions – Unlike a 401(k) or an IRA, there is no limit on your contributions
Life Insurance – Variable annuities often include a death benefit
Unlike Certificates of Deposit (CDs) which are backed by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account or Treasury Bills (T-Bills) which are backed by the full faith and credit of the U.S. Government, the only protection for an annuity is the financial strength of the insurance company that issued it. Annuities should only be purchased from highly-rated insurance companies.
There are two key companies that rate insurers for this purpose:
A.M. Best Company
Oldwick, New Jersey
(908) 439-2200
ambest.com Look for a rating of at least A-
Standard & Poor's
New York City
(212) 438-2000
standardandpoors.com Look for a rating of at least AA
The earnings of a variable annuity can grow on a tax-deferred basis. When you do take a withdrawal, earnings are taxed as ordinary income. If you are unhappy with the performance of a variable annuity you can convert it into another contract with different features that may help it better meet your needs – without any tax penalties. This is called a “tax-free 1035 exchange” and is named after the section of the IRS code that permits it.
There are also some expenses associated with a variable annuity:
Surrender charges are assessed if you take your money out early. The longer you hold an annuity, the lower the surrender charge. The normal holding period for an annuity is from six to eight years. Surrender charges start at the beginning of that period at perhaps 6% of the value of the annuity. By the sixth or seventh year they will drop to 0%.
Expect to pay mortality and expense charges of about 1.25% per year cover the cost of a death benefit. Plan also to pay a small administrative fee to cover the costs of record-keeping.
Estate Protection
Most annuities will bypass probate and simply pass directly to the investor's heirs. Annuities often include a death benefit, so a beneficiary is normally designated as part of the contract. Note also that annuities are also generally protected from creditors.
Summary
While a variable annuity can offer greater returns than other investments because of the ability to take advantage of market forces, it also carries both a greater risk and higher overall costs.
Remember that a variable annuity is a security. Always read the prospectus carefully before you invest, and seek the advice of a registered investment adviser with experience selling complex financial products.