Variable annuities offer advantages to long-term investors: tax-deferred growth of earnings, a variety of professionally managed investment options, a death benefit that may help protect annuity assets for beneficiaries and a steady income in retirement.
Is a Variable Annuity Right For You?
First, understand what a variable annuity is and how it works. A qualified financial professional can help. You can also read "What is a Variable Annuity?" for more information.
Like any retirement vehicle, the suitability of a variable annuity depends upon your individual goals and circumstances. A variable annuity may be an appropriate component of your overall investment strategy in one or more of the following scenarios:
- You want retirement income you can't outlive. If making your money last over a 20- or 30-year retirement is a concern, a variable annuity with guaranteed lifetime payment options could be right for you.
- You want tax-deferral and insurance guarantees. If you are looking primarily for tax-deferral, you should be aware that other retirement vehicles also offer tax-deferral. Generally, you should consider purchasing a variable annuity only if you want the insurance guarantees it provides. All guarantees are backed by the claims-paying ability of the issuing insurance company.
- You want supplemental retirement savings. If you have Internal Revenue Service (IRS) imposed contribution limits on your employer-sponsored retirement plans and IRAs, a variable annuity allows you to set aside additional savings.
- You believe your tax bracket will be lower once you retire. Once withdrawals begin, earnings are taxed at your ordinary income tax rate. A lower tax bracket during retirement (compared to your working years) may help reduce the amount of taxes you may pay.
- You like to actively manage your investments but are concerned about transaction costs. Most variable annuity contracts allow you to transfer funds between investment options (also called subaccounts). Some annuities may limit the number of transfers made per year or may charge a fee for additional transfers over that limit. Further, transfers between subaccounts do not incur any current tax liability.
- You currently own a non-qualified variable annuity and would like to lower costs. If you already own a non-qualified variable annuity, the IRS allows you to transfer the account value to another non-qualified variable annuity contract tax-free (known as a "1035 exchange"). Typically, a 1035 exchange is made to lower overall costs, or to gain access to more desirable contract features. Be sure you carefully consider a 1035 exchange. In some cases, you could forfeit a substantial death benefit on the existing annuity or lose benefits you've been paying for. You may also be subject to a new surrender charge period.
If you think a variable annuity might be right for you, also consider these important factors:
- Issuer financial strength. Because a variable contract can last for decades, you should be confident about the financial strength and longevity of the issuing insurance company. Check with the issuer's financial strength and claims-paying ability rating from independent rating agencies such as Standard & Poor's, Moody's, A.M. Best, and Fitch. Remember, ratings do not apply to the safety or performance of the subaccounts.
- Fees and expenses. Each investment option charges a management fee. In addition, the issuing insurance company charges "mortality and expense" fees as well as an annual administrative fee. Additional fees may also apply if you elect optional benefits with your contract.
- Surrender charges. If you withdraw funds from a variable annuity within a certain period, the insurance company may apply a "surrender charge".
- Tax implications. Withdrawals of taxable amounts are subject to ordinary income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply.
Make sure you carefully read and understand the variable annuity prospectus, which includes detailed information about the contract's benefits, risks, and costs, before you invest.