One of the retirement planning investments that is being talked about more than ever is the variable annuity. Annuities have been around for a long time but the way they work has changed dramatically over the past decade or so. The annuities people were buying in the 80’s and 90’s are vastly different from the annuities that people are buying today. An annuity is essentially an investment made through an insurance company with associated terms, conditions, and promises that make the performance of that investment predictable and stable for the investor.
There are several different types of annuities and it can be hard to distinguish the differences between fixed annuities, immediate annuities, deferred annuities, variable annuities, and others. The fastest growing category of annuities today is the variable annuity because of the following features for investors.
Tax Deferral: Any annuity is tax deferred so any gains, interest, and dividends are treated just like they are in a qualified retirement account. It’s important to note that annuities are purchased with dollars that have already been taxed, so over time the contract owner will have a principal or cost basis and a base of earnings. When money is withdrawn from any type of annuity, the earnings come out first and they are taxable as ordinary income, just like funds withdrawn from an IRA. They are a great option for people who are already maxing out their contributions to retirement accounts but who still want to save more money for retirement.
Guarantees: It’s rare to be able to use the word “guarantee” with any investment, but the terms associated with any annuity contract are guaranteed, based on the full faith and credit of the insurance company. Ratings agencies grade the financial strength of insurance companies to help investors identify carriers that have the best chance of being able to keep their promises. It’s important to remember that the guarantees are only as good as the insurance companies making them.
Living Benefits: Variable annuities offer a wide array of living benefits that can be added to any contract. For example, accumulation benefits are riders that guarantee a growth rate on the money in the contract regardless of how the underlying investments perform. Money invested in variable annuities is generally spread among a portfolio of mutual funds, giving it a chance to grow when the market cooperates but providing a guaranteed rate of return if markets act like they did in 2008. Income benefits are also available to guarantee a stream of income for life as long as the owner of the annuity stays within the prescribed withdrawal rate. For most carriers, annuity owners are guaranteed between 5 and 7 percent of their accumulated income base each year.
Death Benefits: Like any retirement account, annuities have beneficiaries that are positioned to receive any assets in the contract that the owner hasn’t collected as income. In the old days, buying an annuity was like making a bet with an insurance company and if the owner died before the funds had been collected as income, the insurer kept the difference. Today, annuities act much more like life insurance policies with defined death benefits that can take care of loved ones in the event of the owner’s passing.