Variable Annuity Investment Tips
Variable annuities are currently riding a wave of popularity, notwithstanding that variable annuity investment is reputedly complicated and difficult. Fortunately, the principles of efficient shopping can also apply to variable annuity investment. If there is one thing that Americans know how to do, it is shop.
Buy On The Layaway Plan
Annuities are investments that are directed toward retirement, not financing the purchase of a car or a vacation. Withdrawals before the annuity holder reaches age 59 ½ are subjected to a 10% penalty levied by the IRS. Early withdrawals are penalized by surrender charges imposed by the insurance company.
Variable annuity investment vehicles tend to favor long-term rather than short-term investing horizons. Equity mutual funds and bond funds are appropriate growth investments because they may produce high rates of return, but in any particular year the value of the investment may decline. Over the long term, the likelihood of a positive return is much greater than it is in any one year. Thus, the purchase of a variable annuity implies a buy-and-hold philosophy aimed at funding retirement.
Stay Well Hydrated While Shopping Because Variable Annuities Don’t Offer Much Liquidity
The tax penalty and surrender charges that threaten early withdrawals from variable annuities make them a poor source of liquid funds. It goes without saying that an investor will pull out all stops to cope with a life-threatening situation, but tapping a variable annuity to fix the car or finance a brief period of unemployment should be studiously avoided. Annuities usually make limited provision for penalty-free withdrawals – up to 10% or principal or previous year’s interest, for example – so are somewhat more liquid than bank CDs. Even this money has a high implicit cost, however, since it liquidates funds that would otherwise grow and compound tax-deferred. Sound financial planning prescribes a source of liquid funds to meet emergencies, with variable annuities as a last resort.
Read The Label
Variable annuities are inherently complicated because they embody both investment and insurance features. Moreover, variable annuity investment is controlled by the annuity holder and its vehicles span most of the risk/return spectrum, ranging from money-market funds to growth stocks. Surrender charges, usually imposed in the first 3-10 years of the accumulation period, will penalize annuity holders who withdraw any substantial fraction of their investment. Those charges may be waived for reasons such as disability or the death of a spouse.
Variable annuities are retirement-oriented investments, intended to support the investor after his or her working days are over. That alone should command the investor’s full attention. The foregoing list of complicating factors is the clincher: There is no excuse for failure to understand how the variable annuity works before buying one.
This Isn’t Your Father’s Annuity – Or Your Grandfather’s
Fixed annuities are fixed-income investments, in the same category as government bonds. Their rate of return doesn’t change over a specified time period. That makes them suitable for older, conservative investors with reduced tolerance for risk. While indexed annuities have greater variability of return, their protection of principal and dampening of index fluctuations make them a close cousin of fixed annuities. Immediate annuities pay out quickly; they are ideal for people who have reached retirement age.
Variable annuities are a different animal altogether. Traditional variable annuities embrace volatility and variability of return by tying the credited rate of return to the performance of the equity mutual funds (or bond funds) in their subaccounts. (Unlike individual bonds, bond funds have no specific maturity date, causing the value of the fund to fluctuate in accordance with market interest rates.) They are growth-oriented investment vehicles, most suitable for younger investors with a high tolerance for risk. Older investors should be careful to limit the fraction of their portfolios devoted to variable annuities.
Don't Just Shop, Implement a Solid Retirement Strategy
Purchasing an annuity is a big decision. Online research is a good start, but prudent investors should discuss all their options and risks with an independent financial advisor. Request a free, no-obligation consultation today, along with a report of current rates on brand-name annuities.Speak with an advisor over the phone about annuities for FREE.
Some Things Are Best Done By Professionals
Professionals and business owners often view variable annuity investment as an excellent repository for wealth. As life-insurance products, variable annuities enjoy protection from attachment in liability litigation in many states. Meanwhile, their mutual-fund and bond portfolios are perfect vehicles for long-term growth, and that growth is tax-deferred until the annuity holder takes distributions, presumably in retirement.
You Get What You Pay For
Variable annuity investment products also include insurance features on the side. The inclusion of a death benefit does not automatically make a variable annuity a perfect substitute for a life insurance policy. The fundamental purpose of life insurance is to replace income lost due to unexpected death. Buying life insurance is not the only way to eliminate this risk, but it is custom-made for that purpose. Mortality-risk reduction is best considered a secondary benefit of variable annuity investment.
And You Pay For What You Get
Variable annuity investment combines the benefits of mutual-fund and bond investment, tax-deferred growth of resulting gains, a death benefit and guarantees of minimum returns, income and withdrawals. Each of these benefits is economically costly to produce and the annuity holder pays those costs through the purchase payments, fees and expense payments made to the insurance company.
Annuities in general and variable annuities in particular are often criticized for carrying high price tags. Since annuities are a unique combination of investment and insurance, this criticism must be carefully evaluated. Presumably, critics really intend to suggest that some of the benefits offered by variable annuities are worthless or at least not worth their cost. This is the heart of the matter – buyers should appreciate that each feature of a variable annuity has a cost and should verify that the benefit of that feature exceeds its cost.
A Guarantee Is Just A Piece Of Paper
Annuities are distinguished by their use of guarantees – interest-rate guarantees, death-benefit guarantees and more. Variable annuities are notable because the guarantees coexist alongside investments that fluctuate in accordance with market conditions. Today’s variable annuities offer guaranteed withdrawals and guaranteed income regardless of market conditions. Annuity contracts such as these place even more importance on the underlying basis for the guarantees.
In principle, variable annuities are guaranteed by the complex pattern of hedged assets that have been constructed to counteract the risk of alternative financial scenarios. Since these constructions have not been tested by experience, however, the ultimate guarantor is the financial strength of the issuing insurance company. Fortunately, a handful of rating agencies specialize in evaluating and publicizing the financial strength of life-insurance companies. No investor should purchase a variable annuity without first investigating the issuer’s financial strength.
Most people are not investment experts, but if we had to be experts on every purchase, we could never buy auto repairs or computers or medical services. Thank goodness that most of what we need to know we learned at Wal Mart.
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