Variable annuities are often referred to as “mutual funds with an insurance wrapper.”* A variable annuity is a contract between you and an insurance company. In exchange for a series of premiums (investments) or a lump-sum premium, the company agrees to make periodic payments to you beginning either immediately or at some future date. Because this guarantee is made by the insurance company, you’ll want to be sure of the company’s financial strength and stability before making a purchase.
With a variable annuity, you choose from a range of investment options, called subaccounts, and the value of your annuity fluctuates depending on the performance of the options you select. These subaccounts are generally a selection of mutual funds that are made available by the insurer.
A variable annuity has two phases: an accumulation phase and a payout phase. During the accumulation phase, you pay premiums and decide how to allocate them among the investment options. The growth in the account is tax-deferred until you start taking distributions.**
You can choose how you receive income during the payout phase. Common payout options include an income for the remainder of your life, payments for your lifetime and that of your spouse, payments for a certain number of years or some combination of these. You may be able to choose between fixed payments and payments that vary based on the performance of your investment options. Advantage: You can choose an income you can’t outlive.
Variable annuities also offer a death benefit. Your beneficiary will receive a specified amount – typically, at least the amount that you’ve paid in premiums – if you die before the insurer starts making payments to you. So, your beneficiaries will usually get to recoup at least the amount you invested, even if your investments have declined in value. However, this insurance feature adds to the cost or annual expenses of the annuity. Many annuities offer other types of optional investment guarantees called "riders". While these optional features may appear attractive, they can be complicated and are offered at an additional cost.
Consider Carefully When Putting a Variable Annuity in Your
403(b) or 457 Plan
The biggest advantage of variable annuities is tax-deferred growth, but if you put a variable annuity into your 403(b) or 457 plan that is already tax-deferred, you receive no extra benefit. You may be able to invest in similar mutual funds directly and purchase other features – such as life insurance at lower cost.
* Source: AnnuityShopper.com
** Taxes are due upon withdrawal at ordinary income tax rates. Withdrawals made prior to age 59 1/2 may be subject to a 10% IRS penalty. Premature withdrawals may also be subject to a surrender fee charged by the insurer.