Variable annuity

Definition

A variable annuity is a type of investment product that allows individuals to invest their funds in a variety of securities, with the return based on the performance of those investments. Unlike fixed annuities, where the payout amount is predetermined, variable annuities offer the potential for greater growth through market exposure, but also come with increased risk due to market fluctuations. Investors can typically choose from a range of investment options, making it a flexible retirement savings tool.

5 Must Know Facts For Your Next Test

1. Variable annuities are often used as a means of retirement savings and can provide income during retirement, but their value can fluctuate based on the performance of the underlying investments.
2. Investors in variable annuities may incur fees such as management fees, mortality and expense risk charges, and surrender charges, which can affect overall returns.
3. Unlike fixed annuities, variable annuities do not guarantee returns; instead, they carry investment risk, meaning investors could potentially lose principal if the market performs poorly.
4. Variable annuities typically allow for tax-deferred growth on earnings until funds are withdrawn, which can enhance their attractiveness for long-term investors.
5. Most variable annuities offer optional riders for additional features like guaranteed minimum income or enhanced death benefits, which can come at an extra cost.

Review Questions

• How does a variable annuity differ from a fixed annuity in terms of investment risk and potential returns?
  • A variable annuity differs from a fixed annuity primarily in the level of investment risk and potential returns. While fixed annuities provide guaranteed payouts regardless of market performance, variable annuities allow investors to choose from multiple investment options whose values can fluctuate. This means that variable annuities have the potential for higher returns when markets perform well but also come with greater risks of loss if investments underperform.
• What are the key fees associated with variable annuities, and how can they impact an investor's overall return?
  • Key fees associated with variable annuities include management fees for the investment options chosen, mortality and expense risk charges for insurance guarantees provided by the issuer, and surrender charges if funds are withdrawn before a specified period. These fees can significantly reduce the overall return on an investment in a variable annuity by decreasing the amount of money that remains invested over time. It's essential for investors to carefully consider these costs when evaluating whether a variable annuity aligns with their financial goals.
• Evaluate the advantages and disadvantages of investing in a variable annuity compared to other retirement savings vehicles.
  • Investing in a variable annuity offers advantages such as tax-deferred growth, flexibility in investment choices, and features like death benefits or guaranteed income riders. However, these products also have disadvantages including high fees, potential loss of principal due to market volatility, and complex structures that may confuse some investors. When compared to other retirement savings vehicles like 401(k)s or IRAs, it’s important for investors to weigh these pros and cons based on their individual financial situations, investment knowledge, and long-term retirement goals.

Related terms

fixed annuity: A fixed annuity provides a guaranteed payout amount for a specified period or for the lifetime of the investor, regardless of market conditions.

surrender charge: A surrender charge is a fee imposed when an investor withdraws funds from a variable annuity before a specified period, typically aimed at discouraging early withdrawals.

death benefit: A death benefit is a feature of variable annuities that guarantees a payout to beneficiaries upon the death of the annuity holder, often at least equal to the amount invested.