Pros and Cons of Variable Annuity

Many Americans adopt variable annuity for different investments. Variable annuity is a contractual agreement wherein, the premium is split into separate sub accounts. Here you can make a lump sum payment or a series of payments. Know about the pros and cons of variable annuity and the various risks and advantages it entails, from the following.
Variable annuity is often considered as one of the best retirement planning options. But before going for the buy of a variable annuity, you should be loaded with a bunch of questions to be answered by the insurance agent, broker, financial advisor or planner, and other financial professionals. Since money will be involved in the plan, knowing about the pros and cons of variable annuity would help you realize whether owing the account would be a wise decision. The benefits or payouts of a variable annuity account is entirely governed by the performance of the market and the investment choice. The bottom line of this kind of annuity is that all gains and losses would be borne by the investor. Careful planning and a thorough understanding about the basic pros and cons of this process is what is required for maximum profit and minimal loss.

What is A Variable Annuity?

Variable annuity refers to a contract that is agreed upon by the investor (the owner) and the insurance company. According to this contract, the insurance company commits to pay periodic payments to the owner. The owner may choose to receive the payments either immediately or at a future date. And in return, the owner commits to invest in the insurance company with either a lump-sum amount or with a series of payments.

Advantages

# Unlike a fixed annuity, funds in a variable annuity are subjected to rise. If the stock market and share rise, the funds would also grow bigger. So, a bigger income can be expected in the long run.

# Variable annuity offers periodic payments, death benefits and tax-deferred benefits. Periodic payments are ideal for retirement plans. The annuitant would receive periodic payments for the remainder of his life, from the insurer; as per the agreement. People go for variable annuity lest they should exhaust their assets.

# The death benefits that variable annuity offers is another important factor. Unforeseen incidents may occur which may cause death to the annuitant, before the periodic payments were made by the same. In such a case, the nominated beneficiary (such as the spouse or child) is eligible to get at least the amount of the purchased payments (principle value). An important thing that you need to note here is that the beneficiary would be eligible for the payment while the account is still in force, and the account's value is lesser than the guaranteed amount.

# In a variable annuity, no amount of tax gets levied upon the investment gains, until the withdrawal. This tax-free growth benefit becomes more significant with longer deferred withdrawals. Most people defer their income over 20+ years. Also money transfer from one investment to the other within the plan is also tax free. During withdrawals, the tax deduction will be done at normal income tax rate. This tax-free feature is similar to a Roth IRA (Individual Retirement Account).

# Unlike in other types of annuities, this one gives the freedom to the customer to manage his/her accounts.

# A life-long stream of income can be ensured with the help of variable annuity, as the owner can decide to "annuitize" his/her account at retirement. As mentioned earlier, most people may choose to have their annuity payment to last for 20 years, and some choose for an indefinite period such as for the lifetime of the owner, or his/her beneficiary.

Disadvantages

# The annuity will decrease in its value, if the funds in which the annuity is invested suffer losses. However, this does not happen in the case of a fixed annuity. Also, if the insurer goes out of business, so does the money of the investor.

# The tax-deferred benefits would no longer hold useful if the annuitant avails another plan which offers tax benefits.

# Variable annuities are designed for long-term investments and are not recommended for short-term period. In short-term investments, early withdrawal of money may give rise to substantial taxes and charges. Investment in variable annuities are accompanied with several charges that reduce the account's value and the return on investment. Surrender charges (which are a type of sales charges) are levied on the owner in case of a withdrawal within the first eight or ten years (known as the surrender period). This charge is calculated as a percentage of the withdrawal and is applied in order to meet the expense of the sales agent. The IRS levies a 10% tax penalty on withdrawals before the annuitant turns 59.5 years of age. The surrender charge gradually declines in its value after a period of time; for example, in the first year, the charge may be 6% of the amount withdrawn, 5% in the next year, and when it comes down to the eight year, the charge would be 0.

# Mortality and expense risk charge is levied on the annuitant at the rate of 1.25% annually. The insurance company levies these costs as a recovery for their insurance risks and their payment for selling the variable annuity.

# Although, this plan provides death benefit, it is way too pricey to be worth it, unless of course the investor passes away in a young age.

# Admin or management fee is also incurred by the annuitant. Every year a certain percentage of fee is deducted from the account for record-keeping, paperwork, and for meeting other administrative costs. Mutual funds that are the underlying investment options, impose certain expenses which are borne by the annuitant and paid indirectly. If the variable annuity offers special benefits, then even these come along with certain charges and fees.

Variable annuities are loaded with innumerable advantages and disadvantages, and it might be not possible to explain all of them in black and white. So, a financial professional is the best source of information to help you make the right decision. While considering for a variable annuity, have a thorough idea about the different charges from the prospectus available. The important point is to research and be prepared with all possible queries regarding the annuity.
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