A Variable (Deferred) Annuity is designed for long-term retirement savings. You pay premiums, either as a lump sum or in installments, into the annuity contract. Unlike a fixed annuity, where the insurer guarantees a set interest rate, a variable annuity allows the owner to allocate their money among a menu of investment options.
These are called “subaccounts,” and they work a lot like mutual funds. They can include stock, bond, and money market portfolios.
The “deferred” part means the payout phase is postponed to a future date, typically retirement.
A variable annuity has two distinct phases: the accumulation phase and the distribution (or payout) phase.
How does the accumulation phase work with a Variable Annuity?
During accumulation, contributions are invested in the chosen subaccounts, and the contract’s value fluctuates with market performance. This is the key feature that separates variable annuities from fixed ones. Their value can grow significantly in strong markets, but value also runs the risk of declining. There is no guaranteed minimum return on the invested portion.
But, a number of people choose variable annuities for another reason: tax-deferred growth. Earnings inside the annuity aren’t taxed as they accrue. You don’t pay taxes until you make a withdrawal. If you have maxed out other tax-advantage tools (like IRAs or a 401(k)), a variable annuity provides another option.
What happens during the distribution phase with a Variable (Deferred) Annuity?
When you decide to take payment (typically at retirement age), the annuity provides the value to you in a series of payments. Payments are often provided by the owner’s choice: a fixed period, payments for life, or payments that continue after the owner’s death for a surviving spouse.
When a withdrawal or payout begins, the earnings are taxed as ordinary income, while the return of principal usually is not.
Unlike other annuity products, you may simply take withdrawals as needed, though withdrawals before age 59½ can trigger a 10% IRS penalty on the earnings portion, in addition to ordinary income tax.
Can a rider help protect against losses?
Because market-based subaccounts carry risk, insurers offer optional riders, usually for an additional annual fee. Riders may address various issues, including:
Guaranteed Minimum Death Benefit, which ensures beneficiaries receive at least a specified amount (such as total premiums paid) if the owner dies before payouts begin.
Guaranteed Minimum Income Benefit, which guarantees a minimum level of income during the payout phase, regardless of annuity performance.
Guaranteed Minimum Withdrawal Benefit, which allows the owner to withdraw a specified percentage annually without depleting the guaranteed base. This remains true even if the account value drops to zero.
Riders provide protection, but they also add costs. And you still have to remember that guarantees are based on the insurer’s financial strength, not a government protective body like FDIC.
What other costs are associated with a Variable Annuity?
Variable annuities typically cost more than other investment vehicles. Additional fees may be incurred for administration, subaccount management, riders, surrender charges and other risks. These can add up several percentage points annually, so you must compare total overall costs and tax benefits with how your money may perform with other vehicles.
Who can benefit from a Variable Annuity?
This financial vehicle is attractive to individuals seeking a combination of market growth potential and some form of guaranteed protection, especially if they have hit limits on other tax-advantaged retirement accounts. Variable Annuities may also provide a lifetime income guarantee that wouldn’t be available through a brokerage account.
So Variable Deferred Annuities have significant potential advantages—and disadvantages. Miser Wealth Partners can help you determine if a Variable Annuity could be an effective part of your portfolio. We welcome you to schedule a consultation with your advisor at Miser Wealth Partners to learn how Variable (Deferred) Annuities could be a good option in your long-term wealth.
