Variable Annuities (2024)

What Are They?

Although variable annuities offer investment features similar in many respects to mutual funds, a typical variable annuity offersthree basic featuresnot commonly found in mutual funds:

1. Tax-deferred treatment of earnings;
2. A death benefit; and
3. Annuity payout options that can provide guaranteed income for life.

Generally, variable annuities havetwo phases:

1. The "accumulation" phase when investor contributions -premiums- are allocated among investment portfolios -subaccounts- and earnings accumulate;
2. The "distribution" phase when you withdraw money, typically as a lump sum or through various annuity payment options.

If the payments are delayed to the future, you have adeferred annuity. If the payments start immediately, you have animmediate annuity.

As its name implies, a variable annuity's rate of return is not stable, but varies with the stock, bond, and money market subaccounts that you choose as investment options. There is no guarantee that you will earn any return on your investment and there is a risk that you will lose money.

Evaluating Variable Annuities

The variety of features offered by variable annuity products can be confusing. For this reason, it can be difficult for investors to understand what's being recommended for them to buy especially when facing a hard-charging salesperson.

Before you consider purchasing a variable annuity, make sure you fully understand all of its terms.Carefully read the prospectus. Here are seven factors you should bear in mind before investing:

Beware of High Pressure Sales Tactics

The marketing efforts used by some variable annuity sellers have recently been under strict scrutiny by regulators. Sales pitches for these products might attempt to scare or confuse investors. One scare tactic used with seniors is to claim that a variable annuity will protect them from lawsuits or seizures of their assets.

Seniors appear to be frequently targeted, with 90-year-olds sometimes sold variable annuities whose withdrawal penalties last for 10 years or more.

A FINRA report found that firms repeatedly go back to the same customers and switch them to a new variable annuity product every few years. The broker will suggest that you switch to a "better" variable annuity in a tax-free exchange. However, it is not disclosed that you will have to hold the variable annuity for many more years before you can touch your money penalty-free. In 2004, the FINRA brought an action against a broker for switching 6,700 customers to a new annuity that earned the broker higher fees. 1,400 customers were likely to lose money on the trade, while the broker made $37 million in commissions, according to the complaint.

In a complaint received by the SEC, the purchasers of a variable annuity were advised that having an annuity as part of their tax-deferred investment account (IRA) was the same as a "double tax-deferred investment." While it's true that one key benefit to purchasing variable products is that earnings on the investment accumulate tax-deferred, a variable annuity within a tax-advantaged account will provide no additional tax savings. It will, however, generate fees and commissions for the broker.

How to Protect Yourself

Brokers recommending variable annuities must explain to you important facts, including:

• liquidity issues, such as potential surrender charges and 10% tax penalties;
• fees, including mortality and expense charges, administrative charges, and investment advisory fees; and
• market risk

Brokers also must collect important information from you about your age, marital status,
occupation, financial and tax status, investment objectives, and risk tolerance to assess whethera variable annuity is suitable for you.

Before purchasing a variable annuity, you should specifically ask the person recommending that you purchase a variable annuity:

• How long will my money be tied up? Are there surrender charges or other penalties if I withdraw funds from the investment earlier than I anticipated?
• Will you be paid a commission or receive any type of a compensation for selling the variable annuity? How much? What are the risks that my investment could decrease in value?
• How much are the fees? Variable annuities have high commissions, typically above 5 percent. The annual fees on variable annuities can reach 2 percent or more of the annuity's value. So do not sign any paperwork until you know exactly what fees and expenses you will have to pay

And remember to ask yourself:

• Am I already contributing the maximum amount to my 401(k) plan and other tax-deferred retirement plans?
• Do I have a long-term investment objective? Am I going to need the money before the surrender period ends (usually at least 7 to 10 years)? Will I need the money before I'm 59?
• Do I understand how the variable annuity works, the benefits it provides, and charges I have to pay?
• Have I read and understood the prospectus?
• Are there special features provided such as added long-term care insurance that I don't need?
• If I've decided to purchase a variable annuity, have I shopped around and compared the features of various variable annuities, such as sales loads and other fees and expenses?
• If I'm being told to purchase a variable annuity or variable insurance as part of my IRA, Keogh or some other tax-deferred retirement account I should remember those products already have a tax advantage.
• Do I have enough money right now to purchase this product? It's dangerous to mortgage my home in order to purchase a variable annuity or variable life insurance product.
• Am I being pressured into making a quick purchase?

Have You Already Purchased a Variable Annuity?Some policies may have a "free look" period that allows you to cancel within a specific period.