- A fixed annuity guarantees a fixed sum of money for the duration of the contract. It can’t go any lower (or up).
- The returns on the mutual funds in which a variable annuity is invested fluctuate. Its worth may increase (or down).
- An instant annuity starts paying out as soon as the buyer pays the insurer a lump-sum payment.
Which is better variable or fixed annuity?
Fixed annuities are, on average, less dangerous than variable annuities. Fixed annuities have a set rate of interest. The interest rate on a contract is unaffected by market volatility or firm earnings. A fixed annuity may be a superior financial option for conservative investors seeking consistency and safety. A prudent investor’s mind may be at peace knowing that their payments will never fluctuate or alter.
Fixed annuities, on the other hand, are less hazardous than variable annuities, therefore they offer less investment flexibility and growth potential. You can obtain your desired return by investing in a variety of securities such as stocks and bonds with variable annuities. The value of a variable annuity is influenced by the stock market. Investments should be chosen by policyholders based on their risk tolerance and time horizon.
Variable annuities may be a better alternative for investors with longer time horizons and are okay with market volatility. They tend to stay up with inflation, allowing investors to make more money during the life of the contract.
Why would you choose a variable annuity over a fixed annuity?
Your account balance and payments fluctuate with a variable annuity, depending on market performance. As a result, it’s usually easiest to conceive of a variable annuity as a personal retirement account (IRA).
A variable annuity and an IRA are both retirement savings accounts that allow you to grow your money tax-free. You pay income taxes at your marginal rate after you start receiving payments. Variable annuities are unique in that they allow you to contribute an unlimited amount to a tax-advantaged account each year, whereas IRAs and 401(k)s have yearly contribution restrictions. They may also have appealing add-on features, such as death benefits, that typical retirement plans lack.
Variable Annuity Rates
The success of the investments in a variable annuity’s portfolio determines its rate of return. Most variable annuities have a number of subaccounts that function similarly to mutual funds and offer a mix of component assets. You get to pick and choose the subaccounts you want, allowing you to create an aggressive or conservative portfolio.
Benefits of Variable Annuities
- Getting the most out of your tax deductions. You may have maxed out your employer retirement plans and IRA if you’re trying to save a lot for retirement. To lock in even more tax-advantaged investment growth, consider a variable annuity.
- Possibilities for growth. Variable annuities allow investors to accelerate the growth of their holdings during the accumulation period by taking advantage of stock market gains, potentially increasing future income distributions during the payout phase.
- Income for the rest of your life. Variable annuities allow investors to spread their gains over a long period of time.
- Death benefit is guaranteed. If you die before your contract’s distribution period and you purchased this form of rider, your survivors may be eligible for a guaranteed payout. Your beneficiaries will be able to work directly with the issuer outside of probate to get their survivor’s or death benefit, as with all annuities. There’s no need to wait for delayed probate courts to transfer your money to the correct people.
Disadvantages to Variable Annuities
Even with all of their advantages, there are still reasons to avoid a variable annuity.
- Fees are relatively high. Variable annuities have an average annual fee of 2.3 percent of the contract value. Fees could rise considerably more if there are more riders. This means that money placed in similar accounts outside of an annuity could yield significantly higher returns.
- Returns that are unpredictable. Stock market fluctuations may cause your investment to underperform your expectations, causing your portfolio to lose value.
- Surrender Fees are a type of fee that is charged when a person gives If you need to access your annuity assets early, you may be subject to steep surrender fees. If you remove funds before the age of 59 1/2, you may be liable to an IRS 10% early withdrawal penalty.
Can you lose money in a variable annuity?
A Variable Annuity can cause you to lose money. Variable annuities are retirement plans that are dependent on investments. You invest in stocks, bonds, mutual funds, and other financial instruments. You will lose money if the investment performance is poor.
What is the point of a variable annuity?
A variable annuity is a tax-deferred retirement vehicle that lets you choose from a variety of investments and then pays you a fixed amount of money in retirement based on the performance of those investments. A fixed annuity, on the other hand, offers a guaranteed payout.
What’s wrong with variable annuities?
Before you go out and buy a variable annuity, be sure you understand the disadvantages of this retirement savings vehicle. The most significant downside of a variable annuity is its cost. Fees on variable annuities can be rather costly. Administrative costs, fees for unique features, and fund charges for mutual funds you invest in are examples of these.
There’s also the risk charge for mortality and expense (M&E). This annual payment, which is typically around 1.25 percent of your account value, compensates the insurance firm for taking on the risk of insuring your money. When all of these fees and charges are included in, variable annuities may be a costly investment.
A variable annuity may yield a lesser return than other types of annuities, in addition to their relatively high cost. Everything is subject to market conditions. Your money is down if they’re down.
Furthermore, the insurance provider determines which investment possibilities you have access to and which you do not. If you have money in mutual funds, you should think about investing directly in them. (When you’re ready to retire, you can put your money into an instant annuity.) Your fees will almost certainly be lower (no M&E fee, at the very least), and your investment options may perform better – plus you won’t have to pay a high early withdrawal fee if you need to access your funds.
Variable annuities, and all annuities for that matter, are essentially unreachable if you have not yet reached retirement age. This is due to the surrender fees imposed by insurance companies in these contracts. A variable annuity, for example, can have a 5-, 7-, or 10-year surrender fee period. That means any withdrawals made during that time that exceed the amount you’ve been granted will be subject to a surcharge of up to 10%. This is in addition to the IRS’s 10% early withdrawal penalty if you’re under the age of 59 1/2.
What is better than an annuity for retirement?
IRAs are investment vehicles that are funded by mutual funds, equities, and bonds. Annuities are retirement savings plans that are either investment-based or insurance-based.
IRAs can have more upside growth potential than most annuities, but they normally do not provide the same level of protection against stock market losses as most annuities.
The only feature of annuities that IRAs lack is the ability to transform retirement savings into a guaranteed income stream that cannot be outlived.
The IRS sets annual limits on contributions to IRAs and Roth IRAs. For example, in 2020, a person under the age of 50 can contribute up to $6,000 per year, whereas someone above the age of 50 can contribute up to $7,000 per year. There are no restrictions on how much money can be put into a nonqualified deferred annuity each year.
With IRAs, withdrawals must be made by the age of 72 to meet the IRS’s required minimum distributions. With a nonqualified deferred annuity, there are no restrictions on when you can take money out of the account.
Withdrawals from annuities and most IRAs are taxed as ordinary income and, if taken before the age of 59.5, are subject to early withdrawal penalties. The Roth IRA or Roth IRA Annuity is an exception.
How do I cash in a variable annuity?
In a recent piece, I talked about some of the disadvantages of variable annuities. The high fees, deceptive guarantees, and tax treatment can make investors feel uneasy.
But what if you’ve purchased a variable annuity and are experiencing buyer’s remorse?
To get out of a problematic variable annuity, you have a few options.
Take the money and run
Terminating the contract is one way to get out of a problematic variable annuity. Yes, you can make a withdrawal. However, depending on the annuity contract and your specific situation, cashing out of an annuity can result in tax penalties and surrender charges, and you may miss out on potential benefits.
When considering cashing out a non-qualified annuity (one that isn’t stored in an IRA), you should compare the annuity’s “cost basis” to its current cash value.
If you’re under the age of 59 1/2, the difference is normally subject to ordinary income tax and may be subject to an additional 10% tax penalty. You’ll also want to think about any surrender charges and when they expire. Most commission-based variable annuities have a “surrender period” during which you must pay a penalty if you want to withdraw money. The surrender charge can be substantial, up to 10% or more in some situations, but it will gradually decrease over time. Surrender charges are commonly used to cover the broker’s up-front commission check.
Pro tip: some annuities provide a “free look” period of a few days during which you can cancel your annuity without paying a surrender price.
It’s also a good idea to look over your annuity contract carefully to discover what benefits you’ll be giving up if you cash out.
Many of annuities’ extra features end up costing more than they’re worth, but some can be beneficial depending on your circumstances.
Even if there are no tax repercussions or surrender charges, an 85-year-old customer in bad health with a variable annuity with a death benefit of $500,000 but a contract value of $400,000 may be better suited keeping their annuity than terminating it.
Due to the complexity of annuity contracts, it’s a good idea to have a specialist examine your contract before making any modifications – one who doesn’t get a commission on product sales.
Exchange or Rollover
The IRS may allow you to exchange one annuity contract for another under Section 1035 of the tax code. This is a good example “You can defer taxes by using a “rescue” method while switching to a lower-cost contract. Investors can swap variable annuities if their existing annuity does not include a surrender charge, but cashing out the annuity would result in a high tax burden. In that instance, it may make sense to convert the annuity for a lower-cost contract from a different provider with much lower fees, no commissions, and no surrender charges than other annuity firms. As a precaution, double-check that exchanging your present contract will not result in any surrender fees or tax ramifications. Because annuity arrangements are complicated, you should seek advice from a tax professional before making any modifications.
In the case of variable annuities owned in an IRA ( “If you have a qualifying annuity, you may usually terminate it and roll the money into a traditional IRA, which allows you to invest in a variety of lower-cost options including index funds, ETFs, or plain old stocks and bonds.
Before making any changes, check to see if there is a surrender price for ending your annuity contract, and assess the benefits and drawbacks of any assurances your current contract provides.
Annuitize or Withdraw Over Time
Annuitization is the process of exchanging the value of your variable annuity for a fixed or fluctuating stream of income payments from the insurance provider. These payments are usually made for the rest of your life or for a certain number of years, and they may include a survivorship option that allows your surviving spouse or beneficiary to continue receiving income payments for a period of time.
If you expect to outlive your expected lifespan, annuitization may be a viable mathematical alternative.
However, the term “lifetime income” used by many annuity providers is a misnomer because, unless you live a long time, the value of the “income” you receive may not surpass what you paid for the annuity in the first place!
It’s also worth remembering that when you annuitize, you normally give up the opportunity to withdraw more than your regular income payout, as well as any death benefits that come with it.
Rather than annuitizing, one option that may make sense, depending on the annuity’s value and guarantees, is to make systematic withdrawals from the annuity.
Some annuities, for example, have a “Guaranteed Lifetime Withdrawal Benefit” rider that allows you to make annual withdrawals of a specified amount (e.g., 5% of the “benefit base”).
Although these riders normally have a high annual cost, the income base may be worth more than the contract value if the underlying investments have performed poorly.
If cashing out or exchanging the annuity isn’t an option, taking annual withdrawals may be a better option.
This “income” may not exceed what you paid for the annuity in the first place, depending on the contract and how long you live, but if you die in the interval, your heirs may collect the contract value or death benefit.
A professional financial advisor can assist you with the calculations.
In the end, variable annuities can be pricey and complicated.
Most people, in my experience, are better served by simpler, lower-cost investments.
And, while getting out of a terrible variable annuity can be tough, it’s critical to learn everything there is to know about your contract.
As a result, you might be in a better position.
What is the death benefit of a variable annuity?
Most variable annuities have a guaranteed death benefit, which implies that if the contract hasn’t already been annuitized, the insurance company will pay the chosen beneficiary if the owner or annuitant dies.
Are variable annuities good or bad?
Fees and expenditures might range from 3% to 3% depending on the insurance company and features chosen.
Surrender penalties are common in variable annuities for the first four to seven years of the term. Withdrawals of more than 10% of the account value are subject to surrender penalties. Withdrawals made before the age of 59 1/2 are subject to a 10% federal excise tax.
Variable annuity distributions that are not regular payments are taxed at ordinary income rates until the contract has no more gains. Loans from non-qualified annuities are taxable distributions. Gains on variable annuities are taxed at regular rates. The lower capital gains rate applies to the majority of long-term investment gains.
When Are Variable Annuities “Good” Investments?
Variable annuities are a type of insurance. They can provide security and predictability. The stock market lost 50% of its value between October 2007 and March 2009. It took four years, from March 2012 to March 2013, to get back to where it was.
Was it a good moment to invest in variable annuities with living benefits? The answer is most likely yes for investors seeking certainty.
For investors who rebalance their investments frequently, no load/low cost variable annuities may be a viable option. Taxable income is not generated by transfers between variable annuity subaccounts.
When Are Variable Annuities “Bad” Investments?
Variable annuities are long-term investments that can help you save for retirement and other long-term goals. If you don’t have alternative investments to fulfill emergency and other short-term needs, variable annuities aren’t a suitable choice.
If you take your money out too soon, you may be subject to taxes, penalties, and insurance company fees. Variable annuities, like mutual funds and other investment products, are subject to risk.
Using a variable annuity in your IRA or pension plan has no tax advantages. The only advantages are the security features they provide. Variable annuities, living benefits, and death benefits all come at a price. If those qualities aren’t crucial to you, there are other options to explore.
Why Do It Yourself?
Variable annuities can be a valuable addition to your retirement portfolio. They are not for everyone, despite their many features and benefits. Make an appointment with your independent insurance agent. They can assist you in determining whether or not a variable annuity is appropriate for you.
Does Dave Ramsey like annuities?
Annuities are burdened by a slew of expenses that eat into your investment return and keep your money locked up. If you want to get your hands on the money you’ve put into an annuity, you’ll have to pay a fee. This is why annuities are not something we endorse.
Remember that annuities are essentially an insurance product in which you transfer the risk of outliving your retirement savings to an insurance provider. And it comes at a high cost.
Here are some of the fees and charges you’ll find associated to an annuity if you’re curious:
- Surrender charges: If you’re not paying attention, this can get you in a lot of trouble. Most insurance firms impose a limit on how much you can withdraw in the first few years after purchasing an annuity, known as the surrender charge “The term of surrender charge.” Any money taken out in excess of that amount will be subject to a fee, which can be rather costly. That’s on top of the 10% tax penalty if you withdraw your money before reaching the age of 59 1/2!
- Commissions: One of the reasons why insurance salesmen enjoy pitching annuities to people is that they can earn large commissions—up to 10% in some cases! Those commissions are sometimes charged individually, and sometimes the surrender charges we just discussed cover the fee. Make sure you inquire how much of a cut they get when you’re listening to an annuity sales pitch.
- Charges for insurance: These could appear as a bill “Risk charge for mortality and expense.” These fees cover the risk that the insurance company assumes when you buy an annuity, and they normally amount to 1.25 percent of your account balance per year. 3
- Fees for investment management are exactly what they sound like. Managing mutual funds is expensive, and these fees pay those expenses.
- Rider fees: Some annuities allow you to add extra features to your annuity, such as long-term care insurance and future income guarantees. Riders are optional supplementary features that aren’t free. There is a charge for those riders as well.
What is the disadvantage of a fixed annuity?
Fixed annuities are often thought of as long-term investments. Fixed annuities have many benefits, but they also have some drawbacks. IRS Penalty of 10% | Any income removed from an annuity before the age of 59.5 is usually subject to a 10% tax penalty by the IRS.
