Key Points
Variable annuities are finding a place in the retirement plans of a growing number of Americans. Over the past few years, sales of variable annuities have surged, with the industry posting its second highest sales ever in 2003. The soon-to-be-retiring Baby Boom generation, attracted by the various income guarantees and so-called "living benefits" now proliferating in the variable annuity marketplace, is expected to fuel continued growth in the years ahead.
Yet before you rush to add a variable annuity to your retirement funding scheme, take some time to understand what variable annuities have to offer in a general sense, and to sort through the host of optional features and their associated fees.
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The Securities and Exchange Commission defines a variable annuity as "a contract between an investor and an insurance company under which the insurer agrees to make periodic payments to the investor, beginning either immediately or at some future date." An individual can purchase a variable annuity by making a single purchase payment or a series of payments spread out over a period of time.
Variable annuities allow you to accumulate retirement assets on a tax-deferred basis and are often used to help supplement more traditional sources of retirement income such as Social Security and pension plans. Variable annuities typically allow you to choose from among a variety of "subaccounts" that, like mutual funds, invest in stocks, bonds, money market instruments, or some combination of the three.1 As with most investments, the value of your variable annuity will vary depending on the performance of the investments you choose.
Features common to variable annuities include:
- Tax-deferred growth: You will pay no taxes on the earnings from your annuity investments until you begin receiving payments.2
- Unlimited contributions: Generally speaking, there is no limit to the amount of money you can put into a variable annuity.
- No mandatory withdrawals: You are not required to begin taking minimum distributions from a variable annuity at age 70½.3
- Death benefit: If you die prior to annuitizing your contract (converting your variable annuity into regular income payments), your beneficiary(ies) is guaranteed to receive a specified amount of money — typically at least as much as you contributed in payments, less any withdrawals.
- Lifetime income benefits: Annuity holders typically can choose from a variety of options for receiving annuity payments, including the option of receiving payments for the rest of your life. For an additional annual fee you can purchase peace of mind in the form of regular, guaranteed income, even if your account balance goes to zero due to withdrawals and/or poor market performance.
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In addition to offering a stream of income that cannot be outlived, many of today’s new annuity products have “living benefits,” optional features available for an added fee that offer exposure to the market’s upside while providing guarantees that help protect your principal investment from market declines and/or provide a minimum future income. In some cases, a combination of these optional benefits may make some variable annuities a potential rollover vehicle.4 The basic types of living benefits are outlined below.5 Guaranteed Minimum Income Benefit (GMIB) — A GMIB guarantees a minimum future income level regardless of how the market performs. This benefit typically requires the owner to meet certain criteria, such as owning the contract for a specified number of years before exercising the benefit, and the owner must annuitize the contract to take advantage of this benefit.
Guaranteed Minimum Accumulation Benefit (GMAB) — This benefit ensures that you retain the value of your purchase payments regardless of investment performance. At the end of a waiting period — typically 10 years — if your contract value is worth less than your purchase payments, the issuer will add the difference to the account.
Guaranteed Minimum Withdrawal Benefit (GMWB) — A GMWB guarantees a return of your purchase payments through fixed annual withdrawals. The annual withdrawals are guaranteed until your principal is returned, even if the contract value declines to zero. Some benefits also guarantee the owner 5% annual withdrawals for life in addition to guaranteeing the principal.
Living benefits are increasingly evolving into new hybrid benefit options, offering a mix of guarantees and participation in the market's potential upside, as insurance companies seek ways to differentiate their offerings in the marketplace. This environment of expanding flexibility and functionality is helping to redefine variable annuities for a new generation of retirement investors. But with added choice comes the possibility for confusion and the need for expert advice.
Your financial advisor can explain the many ways in which a variable annuity can be put to use to meet specific financial needs.
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Living Benefits — Some Basic Types
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Guaranteed Minimum Income Benefit (GMIB)
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Guaranteed Minimum Withdrawal Benefit (GMWB)
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Guaranteed Minimum Accumulation Benefit (GMAB)
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Guarantee
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Guaranteed lifetime payments; requires annuitization
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Guaranteed return of purchase payments over time; withdrawal benefit — not an annuitization option
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Guaranteed retention of account value after 10 years, regardless of market performance
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Waiting period
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10-year waiting period to exercise guarantee
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No waiting period
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10-year waiting period to exercise guarantee
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Payout calculation
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Based on the account’s highest anniversary value and/or purchase payments (less withdrawals) compounded annually at 4% to 6%
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Based on 5% or 7% withdrawals
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N/A
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Duration of benefit
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Lifetime income guarantee
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Payments last until original investment is returned
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Benefit must be renewed according to terms of contract to continue protecting account value from market risk
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Potential uses
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Investors who seek long-term growth potential, have no immediate need for liquidity, but want to guarantee a future stream of income
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Investors who seek equity exposure for growth potential, but also have a need for liquidity in the short term
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Investors who seek long-term exposure to the market’s upside potential as well as principal protection and/or minimum future income
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- Variable annuities provide for tax-deferred investment growth and are often used by retirees to supplement other sources of income such as Social Security and pension plans.
- The soon-to-retire Baby Boom generation is expected to fuel growth of the variable annuity market in the coming years.
- Annuity holders can choose from a variety of options for an additional fee, including death benefits that provide for your beneficiaries and lifetime income benefits that offer a variety of ways to take withdrawals or receive annuity payments.
- Many of today's annuities offer "living benefits," optional features that help investors take advantage of the market’s potential upside while offering guarantees that help protect investment principal from market declines and/or provide minimum future income. In some cases, variable annuities may be a potential rollover vehicle for qualified retirement assets.
- Your financial advisor can explain the many ways in which a variable annuity can be put to use to meet specific financial needs.
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