How-to Guides

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.
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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. 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.
• 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 70 1/2.
• 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.
• 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.

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. The basic types of living benefits are outlined below.

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.

As with any investment, there are risks associated with variable annuities. Because annuities are intended to be long-term investments, many annuity providers impose surrender charges for making withdrawals if an investor has not maintained the account for a designated period. Surrender periods vary and can last as long as 12 years. If you need access to your money in a relatively short time, an annuity may not be appropriate for you.

In addition to the surrender charge, there typically are a variety of fees associated with a variable annuity. For instance, many insurers assess mortality and expense risk charges as compensation for costs associated with the annuity contract. Investors also pay fees and expenses imposed by mutual funds that are the underlying investments. Be aware of commissions that compensate financial advisors who sell variable annuities. Make sure you understand all of the expenses that potentially reduce your total return.
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