Why consider a variable annuity?
Topics for today’s investors
The good news is that Americans continue to live longer a 60-year-old man today will live an average of 21.6 more years and a 60-year-old woman, an average 24.5 years. The not-so-good news is that means retirement may cost you more likely much more than you anticipated when you first started saving for it. To help close the gap between originally anticipated retirement income needs and the sobering reality of what will ultimately be needed to cover those extra years in retirement, many have turned to variable annuities.
An annuity provides a steady, stream of income. Here’s how it works: an annuity is purchased through either a lump sum or periodic payments during what’s called the “accumulation phase.” These payments are invested (hence, the “variable,” since investment performance fluctuates) and may accumulate on a tax-deferred basis. Then, either right away or at some point down the road, payments plus investment gains (if applicable) are withdrawn by the owner, with the investment gains being taxed, as ordinary income, as they are withdrawn.
Variable annuities offer certain features that aren’t available in many other retirement vehicles and provide:
Tax-deferred growth. One of the primary advantages of an annuity is the potential ability to accumulate assets on a tax-deferred basis, similar to a 401(k) plan and an IRA, but upon withdrawl will be taxed as ordinary income. Assets used to purchase an annuity grow without current tax consequences.
A guarantee. In the world of investing, you will almost never hear the word “guarantee.” One different feature about a variable annuity unlike other means of savings for retirement is that the insurance company (from which the annuity is purchased) may make the owner a guarantee. Through the use of optional benefits at an additional cost, variable annuities can provide guarantees linked to the accumulation (the principal investment) and the payouts (the income stream that is derived from the principal).
But you should note, performance of the underlying investments is not guaranteed.
Additional retirement funds. Unlike 401(k)s and IRAs, there is generally no limit on annuity contributions. So once the maximum contribution limits have been reached on traditional retirement plans, an annuity is a way for individuals to continue saving (and deferring taxes). And from a retirement income perspective, consider that some pension benefits are being reduced and that traditional entitlements like Medicare and Social Security may be reduced in the future. An annuity can be a prudent way of planning now to increase income down the road.
Death benefit/Life insurance benefit.
If the annuitant dies before the payments have been completed, a beneficiary (usually, a spouse or child) generally will receive at least the amount of the principal or paid up to that point less any previous withdrawls. So are annuities right for you? The answer depends on a number of factors, including your need for future income to help meet retirement expenses and the desire for certain guarantees. Annuities, by their nature, are long-term investment vehicles that provide a degree of liquidity but are not designed for people who need access to their assets on a short term basis. In fact, withdrawals are subject to surrender charges, if you surrender your annuity within the surrender charge period, and IRA penalties, if you are under 591/ In addition, there are fees and expenses involved in purchasing and holding an annuity.
If you’re concerned about the cost of a retirement that may last 20 years or longer, you should discuss variable annuities with your financial adviser, especially if you’re already contributing the maximum to a 401(k) or other retirement plan at work and an IRA. Your financial adviser will take the time to understand your individual needs and circumstances, so that he or she can help you determine whether annuities might be appropriate for you.