What is a Variable Annuity?
A variable annuity is a contract which an insurance company sells. The contract provides future payments to the holder, based on the strength of the underlying securities of the contract. The insurer ensures a minimum payment but it could vary the rate of return on the underlying securities.
Those securities’ performance, usually mutual funds, specifies the size of the eventual annuity payment.
A variable annuity provides an array of investment choices. Like a variable annuity owner, the value of your investment will depend greatly on the performance of the investment options you choose.
Typically, the investment options for a variable annuity are mutual funds investing in stocks, bonds, money market instruments or some mixture of all three.
Each variable annuity is unique. Most include features that distinguish them from other insurance products and investment options.
How Do Variable Annuities Work?
A variable annuity has two phases: a phase of accumulation, and a phase of payout.
1. The Accumulation Phase
You make purchase payments throughout the accumulation phase, which you can allocate to a series of investment options.
For example, you might designate 40% of your purchase payments to a bond fund, 40% to a U.S. stock fund, and 20% to an international stock fund. The money you have allocated to each investment option of the mutual fund will increase or decrease over time depending on the performance of the Fund.
Furthermore, variable annuities often enable you to allocate part of your purchase payments to a set account. Unlike a mutual fund a fixed account pays a fixed interest rate.
The insurance company may periodically reset this interest rate, but will usually provide a guaranteed minimum (e.g. 3 percent per annum).
Your most important source of information about investment options for a variable annuity is the prospectus. Request the prospectuses for investment options in the mutual fund. Before you allocate your purchase payments among the offered investment options, read them carefully.
You should consider a variety of factors regarding each fund option including the investment goals and policies of the fund, management fees and other expenses charged by the fund, the fund’s risks, and volatility, and whether the fund contributes to the diversification of your overall investment portfolio.
2. The Payout Phase
You can receive your purchase payments plus investment income and gains (if any) as a lump-sum payment at the start of the payout phase or you may choose to receive them at regular intervals (usually monthly) as a stream of payments.
The amount of each periodic payment will, in part, depend on the period you select to receive payments. Be aware that certain annuities will not allow you to withdraw money from your account once you receive regular annuity payments.
Also, certain annuity contracts are structured as immediate annuities, meaning that there is no phase of accumulation and you will start receiving annuity payments immediately after you purchase the annuity.