I spoke to a financial advisor from Bank of America today and he suggested a variable annuity account for my parent. He explained to me what is it and how it benefits the owner. The advantages of a variable annuity account is that it allows you to receive fixed annual payments for the rest of your life when you retire. Also, there is this “stepped up” benefit which allows you to receive payments based on the highest account value you had at any time in the account. Say, you had $2M total account value in 2000 and today (2005) you have only 200K left, your payments will be based on the $2M account value. See below for a detailed explanation of a variable annuity account. After knowing the good side of the variable annuity account, I wanted to know the bad side also. It looks like the account eats off high fees, around 2%, and the account is intended to be invested until retirement age of at least 59.5 or else you will suffered from penalties and taxes.
Does anyone have experience with a variable annuity account? Let’s hear your stories.
What Is a Variable Annuity?
A variable annuity is a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date. You purchase a variable annuity contract by making either a single purchase payment or a series of purchase payments.
A variable annuity offers a range of investment options. The value of your investment as a variable annuity owner will vary depending on the performance of the investment options you choose. The investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three. Although variable annuities are typically invested in mutual funds, variable annuities differ from mutual funds in several important ways:
First, variable annuities let you receive periodic payments for the rest of your life (or the life of your spouse or any other person you designate). This feature offers protection against the possibility that, after you retire, you will outlive your assets.
Second, variable annuities have a death benefit. If you die before the insurer has started making payments to you, your beneficiary is guaranteed to receive a specified amount – typically at least the amount of your purchase payments. Your beneficiary will get a benefit from this feature if, at the time of your death, your account value is less than the guaranteed amount.
Third, variable annuities are tax-deferred. That means you pay no taxes on the income and investment gains from your annuity until you withdraw your money. You may also transfer your money from one investment option to another within a variable annuity without paying tax at the time of the transfer. When you take your money out of a variable annuity, however, you will be taxed on the earnings at ordinary income tax rates rather than lower capital gains rates. In general, the benefits of tax deferral will outweigh the costs of a variable annuity only if you hold it as a long-term investment to meet retirement and other long-range goals.