When Should I Get a Variable Annuity

For many people today, the retirement dream is has become a nightmare. Having to cope with intolerable market volatility, economic uncertainties and, for some, the prospect of lower earnings expectations, planning for retirement is more of an exercise in survival as opposed to preparing to live a dream. No matter where on the retirement time horizon you sit, there needs to be a complete reevaluation of expectations as well as methods to use in securing your retirement future.

One method that is beginning to receive more attention is the variable annuity. With its built in guarantees of principal and income, it offers a viable solution for those with longer time horizons to build towards a secure retirement while mitigating some of the risk. Variable annuities are complex instruments and there are still some elements of risk involved, but for those who have determined that it appropriate for their financial situation the question comes down to when the best time is to get a variable annuity. 

For the answer, prospective investors needs to first thoroughly assess their current financial situation to determine specific concerns, time horizon, risk tolerance, and liquidity needs.  With that, a variable annuity can be more realistically evaluated for its viability as a retirement tool.  Let’s consider each of these personal financial specifications in the context of how a variable annuity works.

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Financial Concerns

Certainly if the need for a secure retirement is among your primary financial concerns, a variable annuity can and should be considered.  There is no other alternative that can guarantee a lifetime of income and that has become a pressing concern for many.  The issue is whether there are still some other pressing financial needs that also have to be addressed, for instance, the funding of a child’s education. 

Variable annuities are long term investments and they require a long term commitment of funds.  Access to funds, while possible, is restricted through hefty surrender fees for early withdrawals as well as tax penalties.  An investor can comfortably commit funds to a variable annuity after all other short and intermediate term concerns have been addressed. 

Time Horizon

From a general timing standpoint, the sweet spot for when a person should invest in a variable annuity is when their retirement is clearly in their sights.  It is typically at a time, later in the earning years, when there are sufficient funds to continue to allocate towards other financial concern, and after contributions to qualified plans have been maximized.  Variable annuity funding should come from excess savings or investable assets that can afford to be reallocated.  In other words, there should be other savings and investments in place that are available for current and future use.  For most people, all of this could come sometime in their 40’s or 50’s.  This provides a long enough timeline to optimize the accumulation and tax advantages of a variable annuity.

Conversely, if you’re retirement date is much closer, for instance when you are in your 60’s, the time horizon may be too short to allow you to optimize the benefits. If, however, you are in a position to defer the variable annuity well into your retirement, it could be viable.  Generally, anything less than a 10-15 year holding period may not be advisable.

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Risk Tolerance

At its core, a variable annuity is an equities investment vehicle which involves market risk.  If you have low or no tolerance for market risk, variable annuities should not be a consideration. If, however, you have an understanding of how to mitigate market risk through diversification and a properly balanced portfolio, you can take advantage of the asset allocation capabilities of variable annuities and compose an investment mix that accommodates your tolerance level.

The other thing to consider is that variable annuities do have other risk mitigating features such as the return of principal guarantee which ensures that, should you die prior to receiving an income from the annuity, your beneficiaries will receive the balance.  There are additional riders that can be purchased that can even protect your principal and its growth while you are living. These are called living benefits.

If your concern for a secure retirement income is matched by your concern for losing your purchasing power due to inflation, then a variable annuity is a strong option.  The other reason for purchasing a variable annuity is the potential for the income payout to increase as markets rise.  With a minimum guaranteed income, you won’t risk much at all when the markets go down.

Liquidity Needs

As mentioned earlier, there are restrictions for accessing your funds.  Most variable annuity contracts include a surrender window during which, if funds are withdrawn, they will apply a fee. Also, if the withdrawal occurs before age 59 ½, the IRS will apply a penalty tax of 10% on top of the ordinary income taxes that are due.  Also, once your annuity contract is converted into an income payout, your funds are then fully committed to the future payout.  If you are in a position to fully commit funds to a long term investment, then the time may be right buy a variable annuity.

When should you get a variable annuity? To summarize:  when your primary focus is on retirement income; your time horizon is just right, you understand your tolerance for risk, and you have addressed your future liquidity needs.  When all these factors line up, then it is the best time to get a variable annuity.

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