Variable annuities expand on the principle of variability of
investment return. The annuity holder assumes full responsibility for
directing the investment performance of the annuity’s accumulation
account. The insurance company provides the annuity holder with a menu
of investment opportunities, ranging from money market funds to bond
funds to funds that are essentially the same thing as mutual funds but
are called “sub-accounts.” (They are called sub-accounts to avoid
confusion with actual mutual funds.)
The purpose of giving the
annuity holder more responsibility and more choices is to enable him or
her to try to earn even larger investment returns than those associated
with fixed annuities and indexed annuities. This, in turn, would make it possible
to enjoy even larger annuity payments in retirement. Investments in
bond funds and stock mutual funds fluctuate in value; so does the
accumulation account of a variable annuity. Variable annuity holders
are given the opportunity to earn a larger return and in return must
bear more risk.
Variable annuity investments can accumulate
tax-deferred because they are life-insurance products. (One feature of
a variable annuity is the option to designate a beneficiary for a death
benefit that would, at a minimum, equal the value of contributions made
to the annuity less any withdrawals made prior to the holder’s death.)
The other side of this coin is that variable annuities have the same
management-related expenses as mutual funds, plus insurance-related
expenses that mutual funds don’t have. These relatively high expenses
mean that other options for achieving tax deferral, such as
contributions to qualified plans, should be exhausted before purchasing
a variable annuity. These same high expenses, plus the higher level of
risk and lack of liquidity imposed by surrender charges, make variable
annuities unsuitable for the elderly.
Recently-developed variable
annuity products advertise “living benefit” riders that guarantee
sizable returns, minimum additions to income and minimum withdrawal
levels regardless of actual market performance. A guarantee is only as
good as what stands in back of it. Even dummies should know enough to
make sure that the issuing insurance company is financially strong. At
least four major rating agencies offer evaluations of all major
insurance companies to allow the public to do just that.
Professionals
and business owners who are threatened with loss of wealth from
liability lawsuits benefit from variable annuity purchases. In many
states, their life-insurance status shields these investments from
attachment in litigation. The high expenses of variable annuities are
simply the price paid for liability protection by this class of people.
As
with other types of annuities, the variable annuity contract contains
useful information that should not be overlooked. This includes
possible limitations on the number of times the annuity holder is
allowed to change the makeup of the investment portfolio, as well as
state taxes on variable annuities passed along to the holder by the
insurance company.