Variable Annuities

Variable Annuities – Flexible Growth with Potential for Lifetime Income

What Is a Variable Annuity?

A variable annuity is a retirement product offered by insurance companies that allows you to invest your contributions in a variety of investment options, typically mutual funds. The value of a variable annuity can fluctuate based on the performance of the underlying investments, making it a unique hybrid between a retirement savings vehicle and an investment product.

Unlike fixed annuities, where your returns are guaranteed, a variable annuity offers the potential for higher returns, but it also comes with the risk that your investment may decrease in value. These products are commonly used by individuals who want to combine long-term growth potential with tax-deferred savings and the option for a guaranteed income stream in retirement.

How Does a Variable Annuity Work?

When you purchase a variable annuity, you contribute a lump sum or make regular payments (called premiums) to the insurance company. Your money is then allocated to different subaccounts, which can include stocks, bonds, or other investment funds. The value of your variable annuity will fluctuate with the performance of the underlying investments.

The growth in a variable annuity is tax-deferred, meaning you won’t pay taxes on the earnings until you start taking withdrawals. This can help your investment compound over time.

When you’re ready to start receiving income, you can choose to annuitize the contract, which converts your accumulated funds into regular payments. These payments can last for a specified period or for the rest of your life, depending on the options you select.

How Variable Annuities Compare to Other Retirement Products

  • Higher Growth Potential: Unlike fixed annuities, which offer guaranteed interest rates, variable annuities allow you to invest in the stock and bond markets, providing the potential for higher returns. However, this also means more exposure to market risk.
  • Tax-Deferred Growth: Like IRAs and 401(k)s, the earnings on your variable annuity grow tax-deferred. This means you won’t pay taxes on your investment gains until you start taking withdrawals, which can help your money grow faster over time.
  • Guaranteed Income Options: Even though variable annuities are investment-driven, they can still offer a guaranteed income stream through annuitization or through various riders (which we’ll discuss in detail below). This makes them a flexible option for individuals who want to balance growth with income security.
  • No Contribution Limits: Unlike IRAs and 401(k)s, variable annuities do not have annual contribution limits. This makes them an attractive option for individuals who have maxed out other retirement accounts and want to continue saving in a tax-advantaged way.
  • Fees and Costs: Variable annuities often come with higher fees than other retirement products, such as mutual funds or IRAs. These fees can include mortality and expense risk charges, administrative fees, and investment management fees. It’s important to weigh these costs against the potential benefits.

How Variable Annuities and Riders Benefit You

  • Growth Potential with Downside Protection: Variable annuities allow you to participate in the stock and bond markets, offering the potential for significant growth over time. By adding riders like the GMAB or GLWB, you can also protect against market downturns or ensure a lifetime income stream, providing both growth potential and security.
  • Tax-Deferred Growth: Like other retirement products, variable annuities offer tax-deferred growth. You won’t owe taxes on the gains until you start taking withdrawals, allowing your investments to compound faster.
  • Customized Retirement Income: With riders like the GLWB or GMIB, variable annuities can offer a steady and reliable income in retirement. This flexibility allows you to tailor your annuity to meet your specific needs, whether you want guaranteed income for life or protection against market losses.
  • Legacy Protection: Death benefit riders ensure that your beneficiaries receive a guaranteed payout, even if your investments have performed poorly. Enhanced death benefit riders offer even more growth potential, ensuring that your loved ones can benefit from your investments.
  • Long-Term Care Support: The long-term care rider provides a dual benefit: it allows you to use your annuity to cover the rising costs of long-term care, while also preserving the remaining funds for retirement or legacy purposes.

Who Should Consider a Variable Annuity and Riders?

  • Individuals Seeking Growth with a Safety Net: If you’re looking for the potential of stock market growth but want some level of protection against market downturns, a variable annuity with a GMAB or GLWB rider might be a good fit.
  • Those Needing Guaranteed Income in Retirement: If you’re concerned about outliving your savings, a GLWB or GMIB rider can provide peace of mind by ensuring that you will have a steady income for life.
  • Retirees Looking for Flexibility and Legacy Planning: Variable annuities offer a blend of growth, income, and protection features. If you want to ensure that your loved ones are taken care of after you’re gone, a death benefit rider or enhanced death benefit rider can help preserve your legacy.

Riders for Variable Annuities

One of the key benefits of variable annuities is the ability to customize your contract with riders. Riders are optional add-ons that can enhance the features of your annuity and provide additional protections or guarantees. Here are some of the most common riders available for variable annuities:

  • Guaranteed Lifetime Withdrawal Benefit (GLWB)
    The Guaranteed Lifetime Withdrawal Benefit (GLWB) rider ensures that you can withdraw a certain percentage of your original investment every year, for the rest of your life, even if the account value drops to zero. This rider provides a balance between maintaining investment growth potential and guaranteeing income in retirement. 
    • Benefit: The GLWB allows you to continue participating in market growth while ensuring that you will receive income for life. This is especially valuable for individuals concerned about outliving their retirement savings.
    • Cost: Typically, there is an additional fee for this rider, which can range from 0.5% to 1.5% of the contract value annually.
  • Guaranteed Minimum Income Benefit (GMIB)
    The Guaranteed Minimum Income Benefit (GMIB) rider provides a guaranteed minimum level of income, regardless of how your investments perform. After a waiting period (usually 7-10 years), you can convert your annuity into a guaranteed stream of income based on either the account value or a predetermined minimum. 
    • Benefit: GMIB ensures that you have a baseline level of income, even if the market performs poorly during the accumulation phase. This rider gives you peace of mind knowing that you will not be left without a source of income in retirement.
    • Cost: GMIB riders typically come with an annual fee of 0.75% to 1.25% of the account value.
  • Guaranteed Minimum Accumulation Benefit (GMAB)
    The Guaranteed Minimum Accumulation Benefit (GMAB) rider guarantees that, after a specified period (usually 10 years), your account will be worth at least a minimum amount, regardless of investment performance. This means that even if the market drops significantly, the insurance company will top up your account to meet the guaranteed minimum value. 
    • Benefit: GMAB protects your principal investment from market downturns, giving you the confidence to invest in higher-risk subaccounts without worrying about losing your initial contributions.
    • Cost: The GMAB rider generally comes with an annual charge of 0.5% to 1% of the contract value.

Death Benefit Rider

The Death Benefit Rider ensures that if you pass away before annuitizing your contract, your beneficiaries will receive a guaranteed payout. This payout can be either the contract’s current value or the amount of your initial contributions, depending on the specifics of the rider. 

  • Benefit: This rider protects your beneficiaries from market losses, ensuring they receive at least the amount you originally invested, even if the market has underperformed.
  • Cost: Death benefit riders are usually charged at a rate of 0.25% to 1% of the contract value annually.

Enhanced Death Benefit Rider
The Enhanced Death Benefit Rider builds on the standard death benefit by offering additional growth features. For example, this rider may guarantee that your beneficiaries receive the greater of the account value, your original investment, or the original investment plus a percentage of the account’s growth (such as 5-7% per year). 

  • Benefit: This rider ensures that your beneficiaries benefit from market gains, even if you don’t live to fully realize them yourself.
  • Cost: Enhanced death benefits typically cost more than standard death benefits, with fees ranging from 0.75% to 1.5% of the account value annually.

Long-Term Care Rider

The Long-Term Care Rider provides coverage for long-term care expenses if you are unable to perform certain daily living activities (such as bathing, dressing, or eating) or if you are diagnosed with a chronic illness. This rider allows you to use your annuity’s funds to cover long-term care costs without incurring withdrawal penalties. 

  • Benefit: This rider offers additional security by providing coverage for the often-exorbitant costs of long-term care, helping to preserve your retirement savings for other uses.
  • Cost: Long-term care riders usually come with an extra fee, ranging from 0.5% to 1% of the contract value annually.

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* Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax, or accounting advice. Estate Planning services are provided working in conjunction with your Estate Planning Attorney, Tax Attorney and/or CPA. Consult them for specific advice on legal and tax matters.