Like fixed annuities, variable annuities offer investors a chance to grow their investment and to create an additional revenue stream. However, unlike fixed annuities, variable annuities do not offer a guaranteed rate of return, which makes them potentially more lucrative and potentially more risky.
Learning how variable annuities work can help you make the right decision about how to incorporate them in your long-term investment strategy, whether you are planning for retirement or for a large financial goal, such as buying a new home.
You purchase a variable annuity from an insurance or investment company, just like you do a fixed annuity. However, unlike a fixed annuity, you do not receive fixed, regular payments over the duration of the annuity. Instead, you are paid returns based on the performance of the investments, which typically include bonds and mutual funds.
You may purchase a variable annuity with a large lump sum, or you may be able to make payments toward the annuity over the life of the contact.
Many people purchase variable annuities to create a steady income stream, usually as part of retirement planning. However, others may purchase variable annuities as part of an overall investing strategy to increase personal wealth. Since payments are based on the performance of the investment options chosen for the annuity, variable annuities may pay out more than fixed annuities. There is a chance that, with the right investment selections, you can see a significant return on your investment. However, the same characteristic that makes variable annuities attractive also makes them risky. If your investment choices perform poorly, you could end up losing money.
Another advantage of variable annuities is that they allow you to defer your tax obligations. You can receive gains in the annuity, but you won’t have to pay taxes on them until you withdraw them. This gives you greater flexibility with tax planning to maximize your financial gains. There are also no annual contribution limits of income limits for variable annuities.
Finally, variable annuities have a death benefit. Instead of forfeiting the money when you die, you can name a beneficiary to continue receiving payments or a lump payout amount.
The Securities and Exchange Commission warns that there are many fees associated with variable annuities, and that proper understanding of the investment options is essential to making an educated choice about purchasing a variable annuity. The SEC recommends requesting a prospectus from the insurance company providing the annuity and reading it very carefully to understand the terms of the contract, the fees, investment options, death benefits and annuity payout options. The SEC recommends using that information to compare the variable annuity to other investment options, such as a 401(k), Roth IRA or mutual funds.
Once you have the information from the prospectus, you can plug in the terms in the above calculator to determine the benefits you can expect to receive. Of course, your exact rate of return will vary according to the performance of the annuity over time. However, you can use the expected rate of return provided by the issuer to determine your anticipated payouts.
Our calculator provides information about how much you can expect to withdraw based on the starting balance, the expected rate of return, the length at which the annuity matures, and the difference between the current tax rate and your expected tax rate when you make the withdrawal. You can use the results to quickly determine if the annuity will help you meet the financial goals you have set, such as creating a revenue stream for retirement or building wealth for a large purchase, such as buying a retirement home.
This tool will help you calculate the present value of a variable annuity. It also provides advice about obtaining structured settlements.