Variable Annuities

What are variable annuities?
Variable annuities are market sensitive investments. Essentially, they are mutual funds wrapped in an insurance contract, providing the upside potential of the share markets, but are simultaneously subject to the downside risk of the stock market.

• The value of the variable annuity contract will go up and down with the economy, or more precisely, with underlying securities that make up the sub-accounts or "mutual funds".
• The underlying securities (stocks, bonds, or other securities), are subject to market volatility, sub-account fees, along with management and expense fees.
• They do provide a death benefit, equal to a guarantee of principal less withdrawals, for which there are additional costs.

An annuity is associated with the tax-deferred accumulation of assets, as well as the "decumulation" or distribution of assets via a series of installments or payments to the annuitant, that may come monthly, quarterly, semi-annually or annually. If the amount of the annuity account value or annuity payment varies, it is called a variable annuity. Variable annuities are sold by life insurance companies, because they include a guaranteed death benefit to your heirs. They are actually tax-deferred investments. If you buy a variable annuity, you select from a range of mutual fund-like investments called sub accounts.

A sub-account's investment performance determines the future value of a variable annuity. Sub-accounts may be conservative funds that invest in bonds with the highest of credit ratings, but variable annuities also offer a vast array of sub accounts that invest in stocks.

Variable annuities should not be confused with the fixed-indexed annuity. The fixed-indexed annuity provides complete safety of principal, minimum interest rate guarantees, moderate upside potential, while also ensuring that all gains are locked-in annually. The variable annuity has no safety of principal, (other than the death benefit), and there are no minimum interest rate guarantees, (other than a fixed account). There is the possibility of more upside potential, but account values are not locked-in, and therefore, are always subject to loss.
Before you invest in a variable annuity, you must ask yourself whether or not you can you accept the risk of the stock market, and simultaneously pay handling fees of approximately 2.5 to 3%.
The variable annuity may be more appropriate for the investor who has already placed sufficient savings in a safe place. In other words, the variable annuity investor has discretionary assets which they can afford to allocate to the potential upward and downward swings of the market. They can afford the additional costs and fees associated with variable annuities, along with the market exposure to loss, as well as gain.

A variable annuity may offer investors "modified guarantees". The Living Benefit Guarantee requires that the variable annuity is maintained for 6 to 10 years, and only then does the modified guarantee become effective. After that time, the investor's account value, plus the "modified guaranteed growth", deemed the Living Benefit Guarantee is returned over a minimum of 10 years. If you are interested in knowing more about the variable annuity with a Living Benefit Guarantee, please click here to contact me.
The *Guaranteed Withdrawal Benefit is the promise of a systematic withdrawal expressed as 5%, 6%, or 7%; note that withdrawal is expressed as a percentage of account value, not a guarantee of interest on your account value. Understand that the withdrawal is comprised of the investor's original principal, or if the withdrawal is not taken immediately, credited interest or earnings may be added to that original principal. The withdrawal will occur over 20 years, and/or the client's lifetime, depending upon a person's age at issue. Regarding the "Guaranteed Withdrawal Benefit" consider that 5% divided into 100% of a persons premium, goes 20 times (5% x 20 = 100%), hence the variable annuity guarantee, is only a guarantee of your original premium, or if you delay taking withdrawals until some time in the future, your account may grow. If you decide to "walk-away" after surrender charges are over, you leave with your account value based on actual market performance minus all costs, fees, and expenses.
Variable annuities with guaranteed withdrawal benefits or living benefit guarantees can be very confusing and are often misunderstood. If you are interested in knowing more about the variable annuity with a guaranteed withdrawal benefit, or living benefit guarantee, please click here contact me.
You should carefully read the prospectus of a variable annuity and the sub-accounts that you select before investing. The investment objective shown in the prospectus indicates the kinds of investments that the fund buys.

In addition to resembling mutual funds, variable annuities also have similarities to life insurance. Similar to a life insurance policy, you name a beneficiary to receive a death benefit if you die. Fees for a variable-annuity contract also resemble those of a life insurance policy:

• Surrender charges. A surrender charge is a fee that you pay if you sell an annuity contract within a certain number of years. Surrender charges can be as high as 9% of the purchase payment, usually falling by 1 percentage point each year.
• Mortality and expense fees. Mortality and expense (M & E) fees, or risk charges, are paid yearly to the insurer to adjust for changes in the risk characteristics of its pool of insured's. M & E fees routinely add up to about 1.25% of an annuity's contract value.
• Administrative fees. A variable annuity's administrative fees are often charged at a flat yearly rate of $30 to $50 per contract.

It's important to remember that variable annuities are already tax-deferred investments. As a result, you receive no additional tax savings if you buy them for other tax-advantaged accounts, however, this not the case with regard to fixed-indexed annuities. The principal reason for considering a fixed-indexed annuity, may not be the tax advantages, but safety of assets, and the ability to participate in the upside potential of the share market index, by way of index linked interest, but not share in any of the markets downside risk. In addition, the fixed-indexed annuity affords an annual 10% withdrawal feature, and allows for the owner to directly name a beneficiary, avoiding the costs and time delays associated with probate.

The Securities and Exchange Commission (SEC), which regulates the variable-annuities industry, advises that you only buy variable annuities after you contribute the maximum allowable amounts to your IRAs and other tax-advantaged accounts.

Because variable annuities have higher fees than other market sensitive investments and are taxed as ordinary income. Therefore, it can take a long time for the returns of the variable annuity to match the investment returns of other tax-advantaged accounts. However, variable annuities may be attractive for long-term wealthy investors, in some cases, because they offer the following features:

• Income security for a spouse or other beneficiary. An annuity is a series of payments that continues until you die. For an extra fee, you can buy a joint-and-survivor annuity option benefit. This benefit continues to provide an annuity, an income stream (usually monthly); to a spouse or other beneficiary if you die first.

• Tax-deferred growth. Variable annuities allow you to make nondeductible contributions that grow tax-deferred until you begin to take withdrawals. Similar to other tax-advantaged accounts, variable annuities have an early-withdrawal penalty if you take out money before you reach age 59-1/2.
• No contribution limits or required distributions. There are no restrictions on how much money you can place in variable annuities, or when you must take money out.
• Death benefits. If you die before you begin to receive an annuity, or before a certain period, your beneficiary continues to receive the annuity as a death benefit. The amount and duration of the death benefit are determined by your total contributions, deducting any annuity payments you may have already received.

You may wish to keep in mind these additional tips:

• Section 1035 exchanges. You can make a tax-free exchange of "one annuity into another. A 1035 exchange is the IRS title given to the tax-free exchange from one annuity to another", you are said to be using an IRS approved Section 1035 exchange. However, if you do a 1035 exchange, you will naturally inherit a new surrender-charge schedule, (as if you rolled over a maturing CD for a new CD with a new time period associated with the new CD) and you may be responsible for any surrender charges remaining on the contract you are exchanging.
• Insurer's credit rating. Variable annuities are only as financially stable as the insurance company that sells them. You should check the insurer's credit ratings. Aim for those annuities sold by insurers with credit ratings of single A or higher.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.