Variable Annuities & Retirement Income Planning
Market Participation and Insurance Guarantees in One Contract. Understand the Tradeoffs.
Variable annuities combine investment options with insurance features that may include lifetime-income and death-benefit protections.
They can also involve market risk, multiple layers of fees, surrender provisions and complex contract rules. Understanding both sides of the contract matters before deciding whether one belongs in your retirement strategy.
What Is a Variable Annuity?
A variable annuity is an insurance contract whose account value can rise or fall based on the performance of investment options selected within the contract.
Unlike a traditional fixed annuity, the contract value is not simply credited a declared fixed interest rate. And unlike a fixed indexed annuity, the account can be directly exposed to investment-market performance through the contract's available investment options.
Variable annuities may also offer insurance features such as lifetime-income benefits, death benefits and other optional riders. Those features can be valuable in the right circumstances, but they can also add cost and complexity.
If You Already Own a Variable Annuity, Start With the Contract You Have.
Many people purchased a variable annuity years ago and no longer remember exactly what they own.
The first question should not be, “Should I replace it?”
The first question is: What benefits, guarantees, costs and restrictions are already built into the existing contract?
An older contract may contain guarantees or benefit provisions that deserve careful review before any change is considered. Conversely, a contract may contain features that are no longer important to the owner's retirement objectives.
How a Variable Annuity Works
Investment Options
Premiums are allocated among investment choices offered within the contract. Account value fluctuates based on the performance of those selections, less applicable contract and investment expenses.
Tax Deferral
In a nonqualified variable annuity, investment gains generally grow tax-deferred until distributions occur. Tax treatment depends upon the type of money used and applicable tax rules.
Insurance Features
Depending on the contract, optional features may provide certain death-benefit or lifetime-income guarantees. Additional charges and restrictions may apply.
Retirement Income
Variable annuities may provide several ways to create retirement income, including annuitization and, when available, contractual withdrawal benefits.
Your Account Value and Your Income Benefit May Be Two Different Numbers.
This is one of the most important concepts to understand when reviewing a variable annuity with an income rider.
Some contracts use a separate value—often called an income base, benefit base or similar term—to calculate contractual income. That value may not be the amount available for withdrawal or surrender.
A benefit base that grows does not necessarily mean your spendable account value grew by the same amount.
The exact terminology and calculation depend upon the individual contract.
What May Actually Be Guaranteed?
The word guarantee needs context. In a variable annuity, the underlying account value can fluctuate with investment performance.
Depending upon the contract and riders selected, an insurance company may instead guarantee a particular contractual benefit, such as:
Lifetime Withdrawal Benefits
Certain contracts may provide a specified withdrawal amount for life when contract requirements are satisfied.
Minimum Income Benefits
Some contracts provide minimum contractual values used for future income calculations, subject to contract provisions.
Death Benefits
Variable annuities commonly include a basic death benefit, and some offer enhanced death-benefit options for an additional charge.
Other Optional Benefits
Available riders vary by insurer and contract and can carry additional charges, eligibility requirements, investment restrictions or withdrawal limitations.
Understand the Fees Before You Judge the Contract.
Variable annuities can contain several separate layers of cost. Depending upon the contract, these may include:
Mortality and expense charges • administrative expenses • underlying investment expenses • optional rider charges • surrender charges or other contract expenses
Fees reduce investment returns, but simply identifying a fee does not tell you whether a contract should be kept or replaced. The appropriate analysis is whether the benefits being received justify the costs and restrictions for the owner's objectives.
Variable, Fixed Indexed or Fixed: They Solve Different Problems.
Variable Annuity
Account value generally participates directly in the performance of selected investment options and can increase or decrease.
Fixed Indexed Annuity
Interest-crediting potential is linked to an external market index according to the contract's formula, without directly investing the contract value in that index.
Traditional Fixed / MYGA
Interest is credited according to the insurer's contractual fixed-rate provisions for the applicable period.
The question isn't which category is “best.”
The question is which risks you are willing to accept, which guarantees matter to you, how much liquidity you need and what role the money is supposed to play in retirement.
Using IRA or Other Qualified Money? Understand the Tax-Deferral Issue.
IRAs and other qualified retirement accounts already provide tax-deferred treatment under applicable tax rules.
Placing qualified retirement assets into an annuity therefore does not create an additional layer of tax deferral.
When an annuity is considered for qualified money, the reason should instead relate to the contract's insurance features, income provisions, investment choices or other characteristics—not an additional tax-deferral benefit.
Thinking About Replacing or Exchanging an Existing Annuity?
This deserves particular care. A new contract may look attractive, but replacing an existing annuity can mean giving up benefits or beginning a new surrender period.
Before considering a replacement or exchange, compare:
Existing Guarantees
What income, death-benefit or other contractual guarantees would be surrendered?
Current Surrender Value
Are surrender charges currently applicable, and what amount is actually available if the contract is surrendered?
Old Costs vs. New Costs
Compare total ongoing contract, investment and rider expenses—not simply one advertised fee.
New Restrictions
Would a new contract restart surrender periods, change investment flexibility or impose different benefit rules?
Never evaluate the new contract in isolation.
The meaningful comparison is what you are giving up versus what you are receiving.
Questions to Ask About Your Variable Annuity
Already Own One? Bring the Contract.
You don't need to understand a 200-page prospectus before asking whether your variable annuity still fits your retirement plan.
A useful review starts with the actual contract, most recent statement and applicable rider information. From there, the important features can be identified and compared with your current objectives.
A review does not begin with a recommendation to replace the contract.
It begins by understanding what you already own, what it costs, what it guarantees, what risks you retain and what would be lost if you changed it.
Before You Keep It, Replace It or Add More Money—Know Exactly What You Own.
If you already own a variable annuity, TUSK can help you organize the important contract information and understand how its features fit into your broader retirement-income strategy.
Bring your most recent statement and contract information. We'll start with the facts.
This material is provided for general educational purposes only and is not intended as individualized investment, tax or legal advice. Variable annuities are insurance contracts and are subject to investment risk, including possible loss of principal. Contract values and investment returns will fluctuate based on the performance of selected investment options. Variable annuities may involve mortality and expense charges, administrative expenses, underlying investment expenses, optional rider charges, surrender charges and other costs. Withdrawals may reduce contract values, death benefits and living benefits and may be subject to surrender charges and tax consequences. Guarantees are subject to the claims-paying ability of the issuing insurance company. Product availability, features, limitations, investment options, expenses, surrender provisions and rider terms vary by contract and carrier. Clients should review applicable prospectuses and contract documents and consult their qualified tax, legal and investment professionals regarding their individual circumstances.