VARIABLE ANNUITIES
A variable annuity is a contract where the full deposit amount is invested in variable subaccounts.
These subaccounts are subject to market fluctuations, unlike a fixed annuity that is invested in principle protected fixed interest funds. The investor can choose from a series of investment options, similar to a series of mutual funds, but also has the guarantee of an insurance component. This insurance component is also called an annuity wrapper.
There are advantages a variable annuity has over a mutual fund: A variable annuity usually has tax benefits and features provided by the annuity wrapper. It offers the opportunity for tax-deferred and compound growth when funds are left to accumulate interest. And, many variable annuities offer optional riders. These can provide living benefits that can be helpful in retirement in exchange for added cost. But, don’t be fooled – a rider does not protect investors from loss. Annuity salespeople may imply that this is the case, but it’s a fact that all variable annuities subject funds to market risk. Investors nearing and in retirement should generally reduce their investment risk with age.
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What Are the Concerns About Variable Annuities?
First, one the biggest drawbacks of variable annuities are the fees. The amount of fees charged to the investor’s account can consist of investment management fees between 1% to 3%, mortality and expense risk charges averaging 1.35%, and administrative charges ranging from 0.1% to 0.5%. There can also be additional charges when optional riders are added. How much could these fees add up to? Say you owned a $100,000 variable annuity and the fees added up to 3.7%. That would mean your account would be charged $3,700 per year. These fees come off the top and are changed even when the value of the annuity is declining.
The performance of the investment subaccounts determines the value of a variable annuity, and performance can fluctuate. The annuity owner bears all investment risk with a variable annuity, which may be greater or lesser in value compared to the original cost when he or she decides to surrender the policy. Compare this a fixed annuity, where the insurance company assumes all risk and guarantees the investor’s principal and a defined interest rate. There is a Guarantee Association in every state that helps pay the claims of financial impaired insurance companies. Fixed annuities are covered by Guarantee Associations up to certain limits, typically $250,000 – $300,000, but variable annuities are not covered at all.
Are you prepared to read 500 or more pages of legal jargon? Variable annuities are sold by a prospectus that can be long and complicated. A prospectus is a legal document detailing what is offered by a variable annuity and is required by the SEC. The language can be quite complicated for the average investor, or even investment representative, as well as lengthy.
