In recent years, variable annuities have been playing an increasing role in the retirement investment strategies of more and more Americans. Boosting this rise in popularity is the fact that the Baby Boom generation is beginning to enter retirement. As such, the various income guarantees and so-called "living benefits" available through many variable annuities are growing in importance.
Yet before you rush to add a variable annuity to your retirement funding scheme, take some time to understand what variable annuities have to offer in a general sense, and to sort through the host of optional features and their associated fees.
Variable Annuities -- A Brief Primer
The Securities and Exchange Commission defines a variable annuity as "a contract between an investor and an insurance company under which the insurer agrees to make periodic payments to the investor, beginning either immediately or at some future date." An individual can purchase a variable annuity by making a single purchase payment or a series of payments spread out over a period of time.
Variable annuities allow you to accumulate retirement assets on a tax-deferred basis and are often used to help supplement more traditional sources of retirement income such as Social Security and pension plans. Variable annuities typically allow you to choose from among a variety of "subaccounts" that, like mutual funds, invest in stocks, bonds, money market instruments, or some combination of the three.1 As with most investments, the value of your variable annuity will vary depending on the performance of the investments you choose.
Features common to variable annuities include:
- Tax-deferred growth: You will pay no taxes on the earnings from your annuity investments until you begin receiving payments.2
- Unlimited contributions: Generally speaking, there is no limit to the amount of money you can put into a variable annuity.
- No mandatory withdrawals: You are not required to begin taking minimum distributions from a variable annuity at age 70½.3
- Death benefit: If you die prior to annuitizing your contract (converting your variable annuity into regular income payments), your beneficiary(ies) is guaranteed to receive a specified amount of money -- typically at least as much as you contributed in payments, less any withdrawals. Keep in mind that that any guarantees are backed by the finanical strength and claims-paying ability of the insurance company issuing the annuity contract.
- Lifetime income benefits: Annuity holders typically can choose from a variety of options for receiving annuity payments, including the option of receiving payments for the rest of your life.
Living Benefit Options -- Driving Today's Annuity Market
In addition to offering a stream of income that cannot be outlived, many of today's new annuity products have "living benefits," optional features available for an added fee that offer exposure to the market's upside while providing guarantees that help protect your principal investment from market declines and/or provide a minimum future income. In some cases, a combination of these optional benefits may make some variable annuities a potential rollover vehicle.4 The basic types of living benefits are outlined below.5
Guaranteed Minimum Income Benefit (GMIB) -- A GMIB guarantees a minimum future income level regardless of how the market performs. This benefit typically requires the owner to meet certain criteria, such as owning the contract for a specified number of years before exercising the benefit, and the owner must annuitize the contract to take advantage of this benefit.
Guaranteed Minimum Accumulation Benefit (GMAB) -- This benefit ensures that you retain the value of your purchase payments regardless of investment performance. At the end of a waiting period -- typically 10 years -- if your contract value is worth less than your purchase payments, the issuer will add the difference to the account.
Guaranteed Minimum Withdrawal Benefit (GMWB) -- A GMWB guarantees a return of your purchase payments through fixed annual withdrawals. The annual withdrawals are guaranteed until your principal is returned, even if the contract value declines to zero. Some benefits also guarantee the owner 5% annual withdrawals for life in addition to guaranteeing the principal.
Living benefits are increasingly evolving into new hybrid benefit options, offering a mix of guarantees and participation in the market's potential upside, as insurance companies seek ways to differentiate their offerings in the marketplace. This environment of expanding flexibility and functionality is helping to redefine variable annuities for a new generation of retirement investors. But with added choice comes the possibility for confusion and the need for expert advice.
Your financial advisor can explain the many ways in which a variable annuity can be put to use to meet specific financial needs.
| Living Benefits -- Some Basic Types |
|---|
| |
Guaranteed Minimum Income Benefit (GMIB) |
Guaranteed Minimum Withdrawal Benefit (GMWB) |
Guaranteed Minimum Accumulation Benefit (GMAB) |
| Guarantee |
Guaranteed lifetime payments; requires annuitization |
Guaranteed return of purchase payments over time; withdrawal benefit -- not an annuitization option |
Guaranteed retention of account value after 10 years, regardless of market performance |
| Waiting period |
10-year waiting period to exercise guarantee |
No waiting period |
10-year waiting period to exercise guarantee |
| Payout calculation |
Based on the account's highest anniversary value and/or purchase payments (less withdrawals) compounded annually at 4% to 6% |
Based on 5% or 7% withdrawals |
N/A |
| Duration of benefit |
Lifetime income guarantee |
Payments last until original investment is returned |
Benefit must be renewed according to terms of contract to continue protecting account value from market risk |
| Potential uses |
Investors who seek long-term growth potential, have no immediate need for liquidity, but want to guarantee a future stream of income |
Investors who seek equity exposure for growth potential, but also have a need for liquidity in the short term |
Investors who seek long-term exposure to the market's upside potential as well as principal protection and/or minimum future income |
Points to Remember
- Variable annuities provide for tax-deferred investment growth and are often used by retirees to supplement other sources of income such as Social Security and pension plans.
- Retiring Baby Boomers are expected to fuel growth of the variable annuity market in the coming years.
- Annuity holders can choose from a variety of options for an additional fee, including death benefits that provide for your beneficiaries and lifetime income benefits that offer a variety of ways to take withdrawals or receive annuity payments.
- Many of today's annuities offer "living benefits," optional features that help investors take advantage of the market's potential upside while offering guarantees that help protect investment principal from market declines and/or provide minimum future income. In some cases, variable annuities may be a potential rollover vehicle for qualified retirement assets.
- Your financial advisor can explain the many ways in which a variable annuity can be put to use to meet specific financial needs.
1An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
2Withdrawals will be taxed at then-current income tax rates. Variable annuities are not suitable for meeting short-term goals because substantial penalties and early surrender changes may apply if you withdraw money early. In addition, withdrawals prior to age 59 ½ may be subject to a 10% IRS penalty. Keep in mind that the insurer may also impose additional early surrender charges.
3This applies to nonqualified annuities only. Qualified annuities (i.e., rollovers) must adhere to required minimum distribution rules.
4Investors do not receive any additional tax benefit by placing qualified retirement plan assets into an annuity, since tax deferral is already provided by the qualified plan. However, an annuity may still be an attractive option if other features such as guaranteed riders and death benefits are important to the investor.
5All living benefits are available for an additional cost. The guarantees associated with living benefits are backed by the claims-paying ability of the issuing insurance company. It is important to weigh the costs against the benefits when adding such options to an annuity contract.
This information is intended to be educational in nature and should not be considered legal, tax, or financial advice. Because no investment strategy, including asset allocation and diversification, can completely eliminate risk, it's important to discuss your personal financial goals and risk tolerance with a financial advisor to map out a course that's right for you.
© 2009 Standard & Poor's Financial Communications. All rights reserved.
